"The foundations of our economy are strong" - Retail sales fell in March as soaring job losses and tighter credit conditions forced consumers to cut back sharply on discretionary spending. Nearly every sector saw declines including electronics, restaurants, furniture, sporting goods and building materials. Auto sales continued their historic nosedive despite aggressive promotions on new vehicles and $13 billion of aid from the federal government.
The crash in housing, which began in July 2006, accelerated on the downside in March, falling 19 percent year-over-year, signaling more pain ahead. Mortgage defaults are rising and foreclosures in 2009 are estimated to be in the 2.1 million range, an uptick of 400,000 from 2008. Consumer spending is down, housing is in a shambles, and industrial output dropped at an annual rate of 20 percent, the largest quarterly decrease since VE Day. The systemwide contraction continues unabated with with no sign of letting up.
Conditions in the broader economy are now vastly different than those on Wall Street, where the S&P 500 and the Dow Jones Industrials have rallied for 5 weeks straight regaining more than 25 percent of earlier losses. Fed chief Ben Bernanke's $13 trillion in monetary stimulus has triggered a rebound in the stock market while Main Street continues to languish on life-support waiting for Obama's $787 billion fiscal stimulus to kick in and compensate for falling demand and rising unemployment. The rally on Wall Street indicates that Bernanke's flood of liquidity is creating a bubble in stocks since present values do not reflect underlying conditions in the economy. The fundamentals haven't been this bad since the 1930s.
The financial media is abuzz with talk of a recovery as equities inch their way higher every week. CNBC's Jim Cramer, the hyperventilating ringleader of "Fast Money", announced last week, "I am pronouncing the depression is over." Cramer and his clatter of media cheerleaders ignore the fact that every sector of the financial system is now propped up with Fed loans and T-Bills without which the fictive free market would collapse in a heap. For 19 months, Bernanke has kept a steady stream of liquidity flowing from the vault at the US Treasury to the NYSE in downtown Manhattan. The Fed has recapitalized financial institutions via its low interest rates, its multi-trillion dollar lending facilities, and its direct purchase of US sovereign debt and Fannie Mae mortgage-backed securities. (Monetization) The Fed's balance sheet has become a dumping ground for all manner of toxic waste and putrid debt-instruments for which there is no active market. When foreign central banks and investors realize that US currency is backed by dodgy subprime collateral; there will be a run on the dollar followed by a stampede out of US equities. Even so, Bernanke assures his critics that "the foundations of our economy are strong".
As for the recovery, market analyst Edward Harrison sums it up like this:
"This is a fake recovery because the underlying systemic issues in the financial sector are being papered over through various mechanisms designed to surreptitiously recapitalize banks while monetary and fiscal stimulus induces a rebound before many banks' inherent insolvency becomes a problem. This means the banking system will remain weak even after recovery takes hold. The likely result of the weak system will be a relapse into a depression-like circumstances once the temporary salve of stimulus has worn off. Note that this does not preclude stocks from large rallies or a new bull market from forming because as unsustainable as the recovery may be, it will be a recovery nonetheless." (Edward Harrison, "The Fake Recovery", Credit Writedowns)
The rally in the stock market will not fix the banking system, slow the crash in housing, patch-together tattered household balance sheets, repair failing industries or reverse the precipitous decline in consumer confidence. The rising stock market merely indicates that profit-driven speculators are back in business taking advantage of the Fed's lavish capital injections which are propelling equities into the stratosphere. Meanwhile, the unemployment lines continue to swell, the food banks continue to run dry and the homeless shelters continue to burst at the seams. So far, $12 trillion has been pumped into the financial system while less than $450 billion fiscal stimulus has gone to the "real" economy where workers are struggling just to keep food on the table. The Fed's priorities are directed at the investor class not the average working Joe. Bernanke is trying to keep Wall Street happy by goosing asset values with cheap capital, but the increases to the money supply are putting more downward pressure on the dollar. The Fed chief has also begun purchasing US Treasuries, which is the equivalent of writing a check to oneself to cover an overdraft in one's own account. This is the kind of gibberish that passes as sound economic policy. The Fed is incapable if fixing the problem because the Fed is the problem.
Last week, the market shot up on news that Wells Fargo's first quarter net income rose 50 percent to $3 billion pushing the stock up 30 percent in one session. The financial media celebrated the triumph in typical manner by congratulating everyone on set and announcing that a market "bottom" had been reached . The news on Wells Fargo was repeated ad nauseam for two days even though everyone knows that the big banks are holding hundreds of billions in mortgage-backed assets which are marked way above their true value and that gigantic losses are forthcoming. Naturally, the skeptics were kept off-camera or lambasted by toothy anchors as doomsayers and Cassandras. Regretably, creative accounting and media spin can only work for so long. Eventually the banks will have to write down their losses and raise more capital. Wells Fargo slipped the noose this time, but next time might not be so lucky. Here's how Bloomberg sums up wells situation:
"Wells Fargo & Co., the second biggest U.S. home lender, may need $50 billion to pay back the federal government and cover loan losses as the economic slump deepens, according to KBW Inc.’s Frederick Cannon.
KBW expects $120 billion of “stress” losses at Wells Fargo, assuming the recession continues through the first quarter of 2010 and unemployment reaches 12 percent, Cannon wrote today in a report. The San Francisco-based bank may need to raise $25 billion on top of the $25 billion it owes the U.S. Treasury for the industry bailout plan, he wrote.
“Details were scarce and we believe that much of the positive news in the preliminary results had to do with merger accounting, revised accounting standards and mortgage default moratoriums, rather than underlying trends,” wrote Cannon, who downgraded the shares to “underperform” from “market perform.” “We expect earnings and capital to be under pressure due to continued economic weakness.”
What happened to all those nonperforming loans and garbage MBS? Did they simply vanish into the New York ether? Could Wells sudden good fortune have something to do with the recent FASB changes to accounting guidelines on "mark to market" which allow banks greater flexibility in assigning a value to their assets? Also, Judging by the charts on the Internet, Wells appears to have the smallest "ratio of loan loss reserves" of the four biggest banks. That's hardly reassuring.
Paul Krugman takes an equally skeptical view of the Wells report:
"About those great numbers from Wells Fargo....remember, reported profits aren’t a hard number; they involve a lot of assumptions. And at least some analysts are saying that the Wells assumptions about loan losses look, um, odd. Maybe, maybe not; but you do have to say that it would be awfully convenient for banks to sound the all clear right now, just when the question of how tough the Obama administration will really get is hanging in the balance."
The banks are all playing the same game of hide-n-seek, trying to hoodwink the public into thinking they are in a stronger capital position than they really are. It's just more Wall Street chicanery papered over with vapid media propaganda. The giant brokerage houses and the financial media are two spokes on the same wheel gliding along in perfect harmony. Unfortunately, media fanfare and massaging the numbers won't pull the economy out of its downward spiral or bring about a long-term recovery. That will take fiscal policy, jobs programs, debt relief, mortgage writedowns and a progressive plan to rebuild the nation's economy on a solid foundation of productivity and regular wage increases. So far, the Obama administration has focused all its attention and resources on the financial system rather than working people. That won't fix the problem.
Deflation has latched on to the economy like a pitbull on a porkchop. Food and fuel prices fell in March by 0.1 percent while unemployment continued its slide towards 10 percent. Wholesale prices fell by the most in the last 12 months since 1950. According to MarketWatch, "Industrial production is down 13.3% since the recession began in December 2007, the largest percentage decline since the end of World War II"....The capacity utilization rate for total industry fell further to 69.3 percent, a historical low for this series, which begins in 1967." (Federal Reserve) The persistent fall in housing prices (30 percent) and losses in home equity only add to deflationary pressures. The wind is exiting the humongous credit bubble in one great gust.
Obama's $787 billion stimulus is too small to take up the slack in a $14 trillion per year economy where manufacturing and industrial capacity have slipped to record lows and unemployment is rising at 650,000 per month. High unemployment is lethal to an economy where consumer spending is 72 percent of GDP. Without debt relief and mortgage cram-downs, consumption will sputter and corporate profits will continue to shrink. S&P 500 companies have already seen a 37 percent drop in corporate profits. Unless the underlying issues of debt relief and wages are dealt with, the present trends will persist. Growth is impossible when workers are broke and can't afford to buy the things the make.
The stimulus must be increased to a size where it can do boost economic activity and create enough jobs to get over the hump. Yale economics professor Robert Schiller makes the case for more stimulus in his Bloomberg commentary on Tuesday:
"In the Great Depression ... the U.S. government had a great deal of trouble maintaining its commitment to economic stimulus. 'Pump- priming' was talked about and tried, but not consistently. The Depression could have been mostly prevented, but wasn’t.... In the face of a similar Depression-era psychology today, we are in need of massive pump-priming again.
It would be a shame if we are so overwhelmed by anger at the unfairness of it all that we do not take the positive measures needed to restore us to full employment. That would not just be unfair to the U.S. taxpayer. That would be unfair to those who are living in Hoovervilles...; it would be unfair to those who are being evicted from their homes, and can’t find new ones because they can’t find jobs. That would be unfair to those who have to drop out of school because they, or their parents, can’t find jobs.
It is time to face up to what needs to be done. The sticker shock involved will be large, but the costs in terms of lost output of not meeting either the credit target or the aggregate demand target will be yet larger." (Robert Schiller, Depression Lurks unless there's more Stimulus, Bloomberg)
A Year of Cockeyed Optimism
"We are starting to see glimmers of hope across the economy." President Barack Obama, April press conference
Even though industrial production, manufacturing, retail and housing are in freefall, the talk on Wall Street still focuses on the elusive recovery. The S&P 500 touched bottom at 666 on March 6 and has since retraced its steps to 852. Clearly, Bernanke's market-distorting capital injections have played a major role in the turnabout. Former Secretary of Labor under Bill Clinton and economics professor at University of Cal. Berekley, Robert Reich, explains it like this on his blog-site:
"All of these pieces of upbeat news are connected by one fact: the flood of money the Fed has been releasing into the economy. ... So much money is sloshing around the economy that its price is bound to drop. And cheap money is bound to induce some borrowing. The real question is whether this means an economic turnaround. The answer is it doesn't.
Cheap money, you may remember, got us into this mess. Six years ago, the Fed (Alan Greenspan et al) lowered interest rates to 1 percent.... The large lenders did exactly what they could be expected to do with free money -- get as much of it as possible and then lent it out to anyone who could stand up straight (and many who couldn't). With no regulators looking over their shoulders, they got away with the financial equivalent of murder.
The only economic fundamental that's changed since then is that so many people got so badly burned that the trust necessary for consumers, investors, and businesses to repeat what they did then has vanished.... yes, some consumers will refinance and use the extra money they extract from their homes to spend again. But most will use the extra money to pay off debt and start saving again, as they did years ago....
I admire cockeyed optimism, and I understand why Wall Street and its spokespeople want to see a return of the bull market. Hell, everyone with a stock portfolio wants to see it grow again. But wishing for something is different from getting it. And cockeyed optimism can wreak enormous damage on an economy. Haven't we already learned this? (Robert Reich's Blog, "Why We're Not at the Beginning of the End, and Probably Not Even At the End of the Beginning")
If the purpose of Bernanke's grand economics experiment was to create uneven inflation in the equities markets and, thus, widen the chasm between the financials and the real economy; he seems to have succeeded. But for how long? How long will it be before foreign banks and investors realize that the Fed's innocuous-sounding "lending facilities" have released a wave of low interest speculative liquidity into the capital markets? How else does one explain soaring stocks when industrial capacity, manufacturing, exports, corporate profits, retail and every other sector have been pounded into rubble? Liquidity is never inert. It navigates the financial system like mercury in water darting elusively to the area which offers the greatest opportunity for profit. That's why the surge popped up first in the stock market. (so far) When it spills into commodities--and oil and food prices rise--Bernanke will realize his plan has backfired..
Bernanke's financial rescue plan is a disaster. He should have spent a little less time with Milton Friedman and a little more with Karl Marx. It was Marx who uncovered the root of all financial crises. He summed it up like this:
"The ultimate reason for all real crises always remains the poverty and restricted consumption of the masses as opposed to the drive of capitalist production to develop the productive forces as though only the absolute consuming power of society constituted their limit." (Karl Marx, Capital, vol. 3, New York International publishers, 1967; Thanks to Monthly review, John Bellamy Foster)
Bingo. Message to Bernanke: Workers need debt-relief and a raise in pay not bigger bailouts for chiseling fatcat banksters.
Source: Mike Whitney
Mike is a well respected freelance writer living in Washington state, interested in politics and economics from a libertarian perspective.
Showing posts with label bank bailouts. Show all posts
Showing posts with label bank bailouts. Show all posts
Friday, 17 April 2009
Wednesday, 15 April 2009
Max Keiser: The British pound is doomed
The British Pound is doomed. Three years ago, while doing our ResonanceFM 104.4 show, “The Truth About Markets,” Stacy and I commented on news that Bradford & Bingley was offering customers 120% mortgages. At the time we pointed out that this was guaranteed to bankrupt B&B and the entire banking sector if they were allowed to continue locking in negative equity deals for customers who were clearly being victimized by predatory lending and banking abuse. Sure enough B&B needed a bailout and that extra 20% on top of the 100% mortgage that the UK tax payer is paying for - is now providing leverage for short sellers to continue to attack the British Pound. The remedy? Halifax just announced 120% re-mortgages for home owners in negative equity. More debt to get out of debt. Reminds me of the woman in Terry Gilliam’s “Brazil” who plastic surgeried herself to death. The British pound, after its recent ‘dead cat bounce’ is a one way bet down as banks are permitted, without any government intervention, to hollow out Britain’s economy unchallenged by law or common sense.
Source: maxkeiser.com
Source: maxkeiser.com
Tuesday, 14 April 2009
The Fake Recovery
Submitted by Edward Harrison of the site Credit Writedowns
I last posted on "Credt Writedowns" on Thursday before the Easter Holidays in two posts very much at odds with one another. The overall thrust of the first post was that the financial services industry in the United States was due to gain from some very advantageous circumstances in 2009. Meanwhile, the later re-post pointed out the continued fragility of the U.S. economy and banking system and focused on liquidity and solvency as unresolved issues. I would like to bring these two posts together here because I believe the concept behind the dichotomy is best described as the Fake Recovery.
Why 'Fake'? This is a fake recovery because the underlying systemic issues in the financial sector are being papered over through various mechanisms designed to surreptitiously recapitalize banks while monetary and fiscal stimulus induces a rebound before many banks' inherent insolvency becomes a problem. This means the banking system will remain weak even after recovery takes hold. The likely result of the weak system will be a relapse into a depression-like circumstances once the temporary salve of stimulus has worn off. Note that this does not preclude stocks from large rallies or a new bull market from forming because as unsustainable as the recovery may be, it will be a recovery nonetheless.
The real situation
In truth, the U.S. banking system as a whole is probably insolvent. By that I mean the likely future losses of loans and assets already on balance sheets at U.S. financial institutions, if incurred today, would reveal the system as a whole to lack the necessary regulatory capital to continue functioning under current guidelines. In fact, some prognosticators believe these losses far exceed the entire capital of the U.S. financial system. Witness a recent post by Nouriel Roubini:
Now, obviously, if we were to face up to this situation, there would be no chance of recovery as the capital required to recapitalize the banking system would mean a long and deep downturn well into 2010 and perhaps beyond. This is not politically acceptable as 2010 is an election year. Nor is the nationalization of large financial institutions acceptable to the Obama Administration. Moreover, bailing out banks to the tune of trillions of dollars while the economy is in depression is equally unacceptable to the American electorate. The Obama Administration is keenly aware of this fact.
These constraints, some artificial and others very real, leave the Administration with limited options.
Engineer recovery
With the preceding constraints in mind, we should remember that the first priority of elected officials in Washington is not necessarily to make the best long-term choices for the American people, but rather to get re-elected in order to have the opportunity to make those choices. It should be patently obvious that a downturn which began in December 2007 would be fatal to many politicians if allowed to continue well into 2010. This is why recovery of some sort must take place before that time - irrespective of whether it is sustainable.
How to engineer recovery is another question altogether. Here again there are a set of political constraints which make things more challenging. First, there are large swathes of the population that are uncomfortable with the huge debt load and deficit spending that a stimulus-induced recovery creates. Moreover, a government-sponsored nationalisation or recapitalisation plan would only increase this deficit spending and these debts.
As a result, the Obama Administration has crafted a plan to circumvent these obstacles.
The stimulus to come from these measures is still in the pipeline and, by the end of this year, will probably add a big kick to the economy. You should note that only the fiscal stimulus required legislative approval. All of the other 'stimulus' has been done without Congressional approval and largely without Congressional oversight. These activities have been specifically designed to be opaque. The government's claims of wanting to increase transparency ring hollow (see my post on Bloomberg's suit against the Fed as an example of what is really happening).
I should also mention that the Federal Reserve has been a large factor here. It is acting in concert with the executive branch in a non-arms length fashion which I believe will have consequences regarding Fed independence down the line.
Other positive economic factors
There are a number of so-called green shoots (a phrase coined by Norman Lamont) of note.
•Jobless claims have plateaued and comparisons to last year are actually declining (see post).
•The U.S. trade deficit is declining significantly as U.S. import demand has fallen off a cliff.
•Inventory liquidation will put U.S. manufacturers in a better position by Q4 and help make quarterly and yearly comparisons favourable.
I linked to the first two bullets of these other factors. And I wanted to spend a little time on factor number three because I think it is important.
Turning my attention to the global economy, after a rather muted beginning, manufacturers around the world have now begun to react aggressively to the economic downturn and inventories are falling aggressively. Chart 5 below depicts US manufacturing inventories as published recently by the Census Bureau. Inventory changes can have a meaningful impact on GDP. There is one example from the 1981-82 recession where the inventory correction subtracted 5% (annualised) from GDP in just one quarter. The current inventory correction is very negative for GDP in Q1 and possibly also in Q2, but it is very difficult to quantify the effect it is going to have. We will have to wait and see.
However, as we must remind ourselves, the stock market is not trading on what is going to happen in Q1 and Q2 of this year. Projecting at least 6-9 months ahead, the stock market is probably already looking ahead to Q4 and possibly even Q1 of next year. And the inventory adjustment currently underway is very bullish for GDP growth later this year and into next. The reason is simple. Manufacturers always overreact. Come Q3 or Q4, they will suddenly sit up and realise that inventories have fallen too much and that they need to produce more. There is no reason to believe that this recession will be any different.
Obviously, this means that U.S. Q1 and perhaps even Q2 GDP will be very low due to the subtraction of inventories now being purged. However, when we get to Q3 and Q4, this effect will be gone and quarterly and yearly comparisons will look favourable. So the inventory purge may mean a huge upside surprise to GDP in the second half of the year and early 2010 - potentially enough to see positive GDP numbers.
A brief reminder of what lurks beneath
Despite the positives from the previous section, there are significant headwinds which may even preclude a positive GDP number. They include:
•Rising joblessness
•Increased savings as households rebuild balance sheets
•Spending cuts by local and state governments
•Decreased capital spending by companies
•A calamitous GM bankruptcy
Moreover, credit availability --and hence GDP will be constrained by numerous factors including the following:
•Declining home values
•Increasing foreclosures
•Commercial property writedowns
•Credit card-related writeoffs
•Junk bond defaults
All of this means that a cyclical rebound is not a foregone conclusion at all.
Tying the threads together
You should be under no illusion that the coming rebound is permanent. Much of it is not. What we are seeing is the makings of a cyclical recovery that might begin as early as Q4 2009 or Q1 2010. How long or robust that recovery is remains to be seen. Moreover, it is still questionable whether we will get any meaningful recovery at all in spite of the 'green shoots' because the banking system in the United States is severely undercapitalised and more asset writedowns are coming due. This is a fake recovery underneath which many problems remain.
Nevertheless, banks are going to earn a lot of money and that is bullish for their shares - at least in the medium-term. Yes, the stock market is overbought right now. However, if banks put together some decent earnings reports over the next few quarters, their shares will rise.
Furthermore, if the banks can earn enough, this cyclical recovery will have legs as banks will then have enough capital to resume lending and that is supportive of the broader market as well. It is still too early to tell how this will play out over the longer-term. For now, I am much more positive on financials, and somewhat positive on the broader market as well.
I last posted on "Credt Writedowns" on Thursday before the Easter Holidays in two posts very much at odds with one another. The overall thrust of the first post was that the financial services industry in the United States was due to gain from some very advantageous circumstances in 2009. Meanwhile, the later re-post pointed out the continued fragility of the U.S. economy and banking system and focused on liquidity and solvency as unresolved issues. I would like to bring these two posts together here because I believe the concept behind the dichotomy is best described as the Fake Recovery.
Why 'Fake'? This is a fake recovery because the underlying systemic issues in the financial sector are being papered over through various mechanisms designed to surreptitiously recapitalize banks while monetary and fiscal stimulus induces a rebound before many banks' inherent insolvency becomes a problem. This means the banking system will remain weak even after recovery takes hold. The likely result of the weak system will be a relapse into a depression-like circumstances once the temporary salve of stimulus has worn off. Note that this does not preclude stocks from large rallies or a new bull market from forming because as unsustainable as the recovery may be, it will be a recovery nonetheless.
The real situation
In truth, the U.S. banking system as a whole is probably insolvent. By that I mean the likely future losses of loans and assets already on balance sheets at U.S. financial institutions, if incurred today, would reveal the system as a whole to lack the necessary regulatory capital to continue functioning under current guidelines. In fact, some prognosticators believe these losses far exceed the entire capital of the U.S. financial system. Witness a recent post by Nouriel Roubini:
The RGE Monitor new estimate in January 2009 of peak credit losses (available in
a paper for our RGE clients) suggested that total losses on loans made by U.S.
financial firms and the fall in the market value of the assets they are holding
would be at their peak about $3.6 trillion ($1.6 trillion for loans and $2
trillion for securities). The U.S. banks and broker dealers are exposed to half
of this figure, or $1.8 trillion; the rest is borne by other financial
institutions in the US and abroad. The capital backing the banks’ assets was
last fall only $1.4 trillion, leaving the U.S. banking system some $400 billion
in the hole, or close to zero even after the government and private sector
recapitalization of such banks and after banks’ provisioning for losses. Thus,
another $1.4 trillion would be needed to bring back the capital of banks to the
level they had before the crisis; and such massive additional recapitalization
is needed to resolve the credit crunch and restore lending to the private
sector.
Now, obviously, if we were to face up to this situation, there would be no chance of recovery as the capital required to recapitalize the banking system would mean a long and deep downturn well into 2010 and perhaps beyond. This is not politically acceptable as 2010 is an election year. Nor is the nationalization of large financial institutions acceptable to the Obama Administration. Moreover, bailing out banks to the tune of trillions of dollars while the economy is in depression is equally unacceptable to the American electorate. The Obama Administration is keenly aware of this fact.
These constraints, some artificial and others very real, leave the Administration with limited options.
Engineer recovery
With the preceding constraints in mind, we should remember that the first priority of elected officials in Washington is not necessarily to make the best long-term choices for the American people, but rather to get re-elected in order to have the opportunity to make those choices. It should be patently obvious that a downturn which began in December 2007 would be fatal to many politicians if allowed to continue well into 2010. This is why recovery of some sort must take place before that time - irrespective of whether it is sustainable.
How to engineer recovery is another question altogether. Here again there are a set of political constraints which make things more challenging. First, there are large swathes of the population that are uncomfortable with the huge debt load and deficit spending that a stimulus-induced recovery creates. Moreover, a government-sponsored nationalisation or recapitalisation plan would only increase this deficit spending and these debts.
As a result, the Obama Administration has crafted a plan to circumvent these obstacles.
1.Moderate fiscal stimulus. The Obama Administration decided not to seek massive stimulus earlier this year because they deemed it non-viable politically.This clears the first obstacle: deficit hawks. Most economists understand that the output gap that has opened up in the American economy is $2 trillion or more whereas the Obama stimulus package was only $800 billion. That leaves a massive hole in output in the U.S. Moreover, the immediate effective stimulus is less. Much of this 'stimulus' will be saved or will not come into play until months from now. Obviously, this is not going to meet the grade (See my comments on this from February).
2.Quasi-fiscal role for the Fed. Having partially assuaged deficit hawks, Obama still needed to close the output gap. Enter the Federal Reserve. You will have noticed that the Federal Reserve has added legacy assets as eligible for the TALF program. In effect, this allows banks to slip tens or even hundreds of billions of dollars in so-called toxic assets off their balance sheets. Mind you, these are assets already on the books impairing banks' ability to loan money. Under normal circumstances, one would expect the Federal Government to take these assets out of the system (bad bank, good bank, nationalization) after being given legislative approval to do so. However, as I have previously stated this approval is not going to be forthcoming. This is why the Federal Reserve is taking these assets on. In so doing, the Federal Reserve is taking on a quasi-fiscal role that re-capitalizes the banking system in order to stimulate the economy by increasing credit availability.
3.Quasi-fiscal role for the FDIC. The new PPIP is a similar end-run around Congress. After all, the role of the FDIC is that it "maintains the stability and public confidence in the nation’s financial system by insuring deposits, examining and supervising financial institutions, and managing receiverships." Meanwhile, the PPIP has the FDIC guaranteeing dodgy assets in a massive transfer of wealth from taxpayers to banks and select investors. (See my previous comments on this issue).
4.End of mark-to-market as we knew it. You should have noticed that most of the assets written down in the past two years have been marked-to-market. Securities traded in the open market are marked to market. Loans held to maturity are not. This is one reason that large international institutions which participate in the securitisation markets have taken the lion's share of writedowns, despite the low percentage that marked-to-market assets represent on bank balance sheets. But, this should end because of new guidelines in marked-to-market accounting. However, the new guidelines do have two major implications. First,there are still many distressed loans on the books of U.S. banks that if marked to market would reveal devastating losses. Second, there will also now be many distressed securities on bank balance sheets that if marked-to-market would reveal yet more losses. In essence, the new guidelines are helpful only to the degree that it prevents assets being marked down due to temporary impairment. If much of the impairment is real, as I believe it is, we are storing up problems for later.
5.Interest rate reductions. One reason often given for a large increase in writedowns at financial institutions had been the coming reset of Alt-A adjustable-rate mortgages in 2009. With the subprime writedowns mostly accounted for, a souring of the much larger pool of Alt-A and Prime residential mortgage loans is the real Armageddon scenario. Well, part of this problem has been temporarily relieved because the Federal Reserve has reduced short-term interest rates to near zero and has begun trying to manipulate long-term interest rates lower by buying long-dated treasury securities.
6.Bank margin increases. Key to the whole program is banks' ability to earn massive amounts of money and re-capitalize themselves through retained earnings as opposed to shedding assets or receiving additional paid-in capital (see post from last April on these three methods of recapitalizing). The market for bank assets is distressed and few banks can get enough capital from private sources or investors. Therefore, Obama's plan hinges on the ability to allow these banks to earn shed loads of money as quickly as possible. If the banks cannot do this, we are going to have a big problem very quickly (Of course, I think the can).
The stimulus to come from these measures is still in the pipeline and, by the end of this year, will probably add a big kick to the economy. You should note that only the fiscal stimulus required legislative approval. All of the other 'stimulus' has been done without Congressional approval and largely without Congressional oversight. These activities have been specifically designed to be opaque. The government's claims of wanting to increase transparency ring hollow (see my post on Bloomberg's suit against the Fed as an example of what is really happening).
I should also mention that the Federal Reserve has been a large factor here. It is acting in concert with the executive branch in a non-arms length fashion which I believe will have consequences regarding Fed independence down the line.
Other positive economic factors
There are a number of so-called green shoots (a phrase coined by Norman Lamont) of note.
•Jobless claims have plateaued and comparisons to last year are actually declining (see post).
•The U.S. trade deficit is declining significantly as U.S. import demand has fallen off a cliff.
•Inventory liquidation will put U.S. manufacturers in a better position by Q4 and help make quarterly and yearly comparisons favourable.
I linked to the first two bullets of these other factors. And I wanted to spend a little time on factor number three because I think it is important.
Turning my attention to the global economy, after a rather muted beginning, manufacturers around the world have now begun to react aggressively to the economic downturn and inventories are falling aggressively. Chart 5 below depicts US manufacturing inventories as published recently by the Census Bureau. Inventory changes can have a meaningful impact on GDP. There is one example from the 1981-82 recession where the inventory correction subtracted 5% (annualised) from GDP in just one quarter. The current inventory correction is very negative for GDP in Q1 and possibly also in Q2, but it is very difficult to quantify the effect it is going to have. We will have to wait and see.
However, as we must remind ourselves, the stock market is not trading on what is going to happen in Q1 and Q2 of this year. Projecting at least 6-9 months ahead, the stock market is probably already looking ahead to Q4 and possibly even Q1 of next year. And the inventory adjustment currently underway is very bullish for GDP growth later this year and into next. The reason is simple. Manufacturers always overreact. Come Q3 or Q4, they will suddenly sit up and realise that inventories have fallen too much and that they need to produce more. There is no reason to believe that this recession will be any different.
Obviously, this means that U.S. Q1 and perhaps even Q2 GDP will be very low due to the subtraction of inventories now being purged. However, when we get to Q3 and Q4, this effect will be gone and quarterly and yearly comparisons will look favourable. So the inventory purge may mean a huge upside surprise to GDP in the second half of the year and early 2010 - potentially enough to see positive GDP numbers.
A brief reminder of what lurks beneath
Despite the positives from the previous section, there are significant headwinds which may even preclude a positive GDP number. They include:
•Rising joblessness
•Increased savings as households rebuild balance sheets
•Spending cuts by local and state governments
•Decreased capital spending by companies
•A calamitous GM bankruptcy
Moreover, credit availability --and hence GDP will be constrained by numerous factors including the following:
•Declining home values
•Increasing foreclosures
•Commercial property writedowns
•Credit card-related writeoffs
•Junk bond defaults
All of this means that a cyclical rebound is not a foregone conclusion at all.
Tying the threads together
You should be under no illusion that the coming rebound is permanent. Much of it is not. What we are seeing is the makings of a cyclical recovery that might begin as early as Q4 2009 or Q1 2010. How long or robust that recovery is remains to be seen. Moreover, it is still questionable whether we will get any meaningful recovery at all in spite of the 'green shoots' because the banking system in the United States is severely undercapitalised and more asset writedowns are coming due. This is a fake recovery underneath which many problems remain.
Nevertheless, banks are going to earn a lot of money and that is bullish for their shares - at least in the medium-term. Yes, the stock market is overbought right now. However, if banks put together some decent earnings reports over the next few quarters, their shares will rise.
Furthermore, if the banks can earn enough, this cyclical recovery will have legs as banks will then have enough capital to resume lending and that is supportive of the broader market as well. It is still too early to tell how this will play out over the longer-term. For now, I am much more positive on financials, and somewhat positive on the broader market as well.
HSBC faces crisis over US credit cards
HSBC faces a meltdown at its US credit card operations where around $50bn (£34bn) has been lent to people with poor credit histories, say analysts.
Write-offs at the credit card arm of HSBC Finance Corporation (HFC), formerly Household, a sub-prime lender, could double to $10bn in 2009, according to brokers. Fears are growing that the bank could be forced to ask shareholders for more cash, on top of the £12.5bn it raised during its recent rights issue designed to bolster its balance sheet.
Analysts at Société Générale said that the strong take-up of the share offer did not necessarily "translate into smooth sailing for HSBC over the next couple of years" as it faced the prospect of rising bad debt and sour loans. The bank is not yet out of the woods, added SocGen.
Of particular concern are loans outstanding at HFC's credit card business, which stood at $49.6bn last year - representing around two-thirds of all HSBC credit card loans. The HFC credit card operation wrote off $5.4bn in bad or doubtful loans in 2008, according to the annual report, but made a profit of $520m. But analysts say that the profit will be wiped out this year and the offshoot will plunge into the red.
HSBC refused to comment on the speculation but said the HFC provisions "would be impacted by factors such as US unemployment and wage growth".
There is no suggestion that HFC's problems will push HSBC as a whole into loss - its businesses outside the US are highly profitable. But the bank, led by Stephen Green, has admitted that its purchase of Household for $15bn in 2003 has destroyed about $10bn of shareholder value.
Last month, the company unveiled a rights issue, slashed the dividend and disclosed that group profits had more than halved to $9.3bn. At the time, HSBC insisted that the proceeds of the cash call were not designed to plug an existing capital shortfall, but would give the bank a competitive advantage over rivals. But two weeks later it announced 1,200 redundancies as part of a review of operations to make it more efficient.
Leigh Goodwin, an analyst with Fox-Pitt, Kelton, said the job cuts were in response to a decline in demand for mortgage and savings products.
At the time of its annual results in March, HSBC chief executive Mike Geoghegan said HFC would stop making loans to new customers. It is also shutting 800 HFC branches in a move to shrink its exposure to the US housing and sub-prime markets.
Dissident shareholder Knight Vinke has demanded that the bank walk away from its HFC investment. It has also flagged up concern that the $34bn difference between the book and market value of HFC would have to be closed at some point, as it doesn't believe that US house prices will recover in the near future. But HSBC has queried Knight Vinke's assessment of the financial strength of HFC.
Source: Guardian
Write-offs at the credit card arm of HSBC Finance Corporation (HFC), formerly Household, a sub-prime lender, could double to $10bn in 2009, according to brokers. Fears are growing that the bank could be forced to ask shareholders for more cash, on top of the £12.5bn it raised during its recent rights issue designed to bolster its balance sheet.
Analysts at Société Générale said that the strong take-up of the share offer did not necessarily "translate into smooth sailing for HSBC over the next couple of years" as it faced the prospect of rising bad debt and sour loans. The bank is not yet out of the woods, added SocGen.
Of particular concern are loans outstanding at HFC's credit card business, which stood at $49.6bn last year - representing around two-thirds of all HSBC credit card loans. The HFC credit card operation wrote off $5.4bn in bad or doubtful loans in 2008, according to the annual report, but made a profit of $520m. But analysts say that the profit will be wiped out this year and the offshoot will plunge into the red.
HSBC refused to comment on the speculation but said the HFC provisions "would be impacted by factors such as US unemployment and wage growth".
There is no suggestion that HFC's problems will push HSBC as a whole into loss - its businesses outside the US are highly profitable. But the bank, led by Stephen Green, has admitted that its purchase of Household for $15bn in 2003 has destroyed about $10bn of shareholder value.
Last month, the company unveiled a rights issue, slashed the dividend and disclosed that group profits had more than halved to $9.3bn. At the time, HSBC insisted that the proceeds of the cash call were not designed to plug an existing capital shortfall, but would give the bank a competitive advantage over rivals. But two weeks later it announced 1,200 redundancies as part of a review of operations to make it more efficient.
Leigh Goodwin, an analyst with Fox-Pitt, Kelton, said the job cuts were in response to a decline in demand for mortgage and savings products.
At the time of its annual results in March, HSBC chief executive Mike Geoghegan said HFC would stop making loans to new customers. It is also shutting 800 HFC branches in a move to shrink its exposure to the US housing and sub-prime markets.
Dissident shareholder Knight Vinke has demanded that the bank walk away from its HFC investment. It has also flagged up concern that the $34bn difference between the book and market value of HFC would have to be closed at some point, as it doesn't believe that US house prices will recover in the near future. But HSBC has queried Knight Vinke's assessment of the financial strength of HFC.
Source: Guardian
Sunday, 12 April 2009
Lloyds bank staff ‘puts frighteners’ on debtors
Bank staff are harassing customers with talk of home repossessions and blacklists.LLOYDS Banking Group staff are intimidating victims of the recession who have fallen behind on loan payments, an investigation by The Sunday Times has found.
Workers at Lloyds debt recovery department were secretly tape-recorded saying they would “put the frighteners on” and “f***” customers who owed the bank money.
The bank staff are incentivised by bonuses and some claimed to be representing a solicitors’ firm, while others pressured customers with repeated calls that left them in tears. Customers were told they would not even be able to obtain a Blockbuster video shop card if they failed to pay back their debt.
The employees would appear to be in breach of the Banking Code, which pledges to customers that banks “will be sympathetic and positive” when dealing with people in financial difficulties.
The tactics were witnessed by an undercover reporter who worked at the bank’s debt recovery office in Hove, East Sussex, for more than three weeks.
Andrew Mackinlay, the Labour MP, said he would be raising this newspaper’s findings in the Commons next week when he is due to speak in a adjournment debate on debt collection. “The current rules on the collection of debt are inadequate and need to be reviewed because they are not being enforced properly,” he said. “There need to be severe financial penalties if companies are found to be harassing customers and treating them badly.”
Lloyds said last week that it would investigate the findings. Sally Jones-Evans, director of collections and recoveries, said: “We do not condone behaviour that breaks our policies and procedures. Our first action is always to gather the facts, but we take action where these [inquiries] substantiate improper behaviour.”
Lloyds is 65%-owned by the taxpayer after receiving billions of pounds of government aid. The bank prides itself on customer service and recently ran television adverts claiming: “Every day we are helping millions of customers get where they want to go in life.”
The undercover reporter began her job as trainee telephone debt collector in mid-March. At the induction, her trainer, Martin, suggested his own bank might share some of the blame for the large number of defaulting customers. They had fallen into debt, he said, because of “bad management of money, a change of circumstances or possibly irresponsible lending”.
The reporter was assigned a mentor, Sebastian, who told her about a recent case of an 85-year-old man who had been granted a £10,000 loan by Lloyds and had only a meagre pension to pay it back. “What were the branch thinking?” he said, before adding: “Bank lending - probably one reason why there’s a bloody recession going on right now.”
The trainers emphasised that the job was not just about retrieving money. They stressed that people should be given realistic repayment targets. But would it work in practice?
The first signs were not encouraging. The salary for a telephone collector is just under £16,000 a year but up to £750 a quarter can be earned from bonuses, awarded for meeting performance targets. Points are given for the amount of money retrieved and the number of calls in an hour. It is in the collector’s interest to make quick calls and persuade customers to pledge large repayments.
The collectors were told to ask for a bank debit or credit card payment for the outstanding amount. The trainer made clear that the credit cards could not be from Lloyds, to ensure the debt would be shuffled away from the bank. The customer, on the other hand, could end up paying higher interest.
Support groups such as National Debtline and the Citizens Advice Bureau (CAB) say it is wrong to shuffle debt in this way. But it appears to be industry practice. Last week the British Bankers’ Association (BBA), which represents the main banks, claimed the customer might have a credit card charging a lower rate of interest.
On the third day of training the reporter and fellow trainees were sent onto the main floor to practise their technique. One of the trainees listened into a call in which a woman was crying on the phone and begging Lloyds to stop calling her.
A collector called Becky was dealing with another distraught woman who said her case was being handled by a debt organisation. She asked Lloyds to approach the organisation. However, after putting down the phone, Becky said she would not deal with anyone else and she would have to keep ringing the woman.
The Banking Code says banks should “liaise with organisations that are giving the customers advice/support”.
The repeat calls were upsetting. Elaine Molloy, a nurse, said she had been called six times a day at work, which she said made her “stressed and upset”. One man said he had been contacted by Lloyds 10 times despite repeatedly telling the callers the person they were seeking was no longer there.
The trainers said a certain amount of pressure could be put on customers. Homeown-ers could be reminded about repossession and others told that they may be credit blacklisted. One line often used by phone operators was: “[You] wouldn’t get a Blockbuster video card, it’s that serious.”
The reporter was training to work in early collections, dealing with people who had defaulted recently. Nearby was late collections, which dealt with people in arrears for five months or more. They used different tactics to get the bank’s money back. Although they are employed by Lloyds, they told customers they were from Sechiari Clark & Mitchell (SCM), the bank’s solicitors. One was overheard saying they would forward details from the conversation to Lloyds.
A spokeswoman for Lloyds said some of the late collection team operated under the SCM name because they were dealing with cases just before legal action was initiated. However, when speaking to our reporter, one phone operative said it was useful to pretend they were not from Lloyds “because we can blame Lloyds for a lot of stuff”.
Last week Nick Pearson, of Baines and Ernst, which helps people organise their finances, said phoning in the name of solicitors was “custom and practice in the industry”.
The early collection department could, if it acts appropriately, put customers on the road to financial recovery. On the other hand, those who fail to keep up their repayments may end up in the recovery department where there are more serious consequences such as court action and credit blacklisting. Because many of the repayment schedules proved unrealistic, customers were more likely to be passed on to recovery, with an impaired record.
This is not helped by the performance target system that is run in the office. Experienced operatives were expected to collect as much as £1,055 an hour.
It gave the operatives an incentive to set monthly repayment plans for higher amounts, which counted towards their target and their bonus. The rush to reach the targets meant that some operatives did not take time to examine customers’ finances to calculate what they could realistically afford.
Martin acknowledged the problem when addressing the new recruits. “It will be tempting because you get bonuses by collecting more money. Some people are stats-driven and do whatever it takes to collect money but that’s what we are trying to get away from,” he said.
The reporter witnessed the results of this system. One woman could barely pay her bills with her benefit payments of £180 a month and yet she had been put on a repayment plan that she could not afford.
The target system made some operatives very pushy. The reporter overheard one operative saying they would “put the frighteners” on a customer who had defaulted on their repayment schedule for the third month running.
One experienced operative explained to the reporter that keeping the phone calls brisk was one of the tricks of the trade. “Short and sharp - the best way to f*** someone, get their money,” he said.
The recipients of his calls were often left bruised. In a five-day period in the run-up to Christmas, five people were reduced to crying down the phone, he said.
Other operatives had clearly worked out their own system for reaching targets. One team leader boasted that he used to collect £7,000 a day before he became a manager. He described how he and a colleague used to block customers’ bank accounts and cards if they looked like they were not going to make the repayments.
“If they’re not going to pay it, then we’ll try and cancel stuff. We used to put blocks on accounts, everything. Loads of times we did that . . . lucky we didn’t get caught.”
One woman regularly collected more than £200,000 a month, according to Sebastian, the mentor. “Some people here tell me that they’ve listened to calls and she was just putting promises [payments] for accounts she wasn’t even agreeing on. I don’t know why they don’t do anything about it,” he said.
Charities and advice groups such as the CAB, the National Debtline and Baines and Ernst say the problem of setting unaffordable repayment plans goes on throughout the industry. “Lloyds are not alone in this,” Pearson said.
Last week Lloyds defended its collection department, saying that it had been scrutinised by an independent body at the end of last year and was found to be complying with the Banking Code.
The review concluded that “customers were treated positively and sympathetically and were not put under pressure to enter unaffordable repayment plans or to increase offers of repayment where they were unable to do so”.
Lloyds also defended its bonus system, saying that money recovered accounted for only a third of the factors making up the award. It said all repayment plans had to be affordable.
Insight: Claire Newell and Jonathan Calvert
‘It’s horrendous, I’ve never been treated so badly’
According to the Banking Code, customers in financial difficulties should approach their bank early. “We will do all we can to help you to overcome your difficulties,” it states.
But that’s exactly what two families say they did with Lloyds Banking Group and they say they were severely let down.
Elaine and Paul Molloy from Cheshire were struggling to pay the mortgage after a temporary rift in their marriage. “When we went into the bank and said we’d got a problem, they said there’s nothing they can do for us until we go five months behind in the mortgage payments,” Paul Molloy said.
Now they are now back together, their debt has grown to arrears of three months, which they can no longer repay and they now fear they will lose their home of 11 years.
Elaine Molloy, a nurse, says she is being harassed by the collection team. She said: “It’s horrendous, I’ve never been treated so badly by the bank and I’ve been with them since I was 17. I get six calls a day [from the collections department]. They were ringing me at work. I get dead stressed out and upset at work when they call, which doesn’t help my job, looking after patients.”
The family of Alan Wells in Swansea suffered a dramatic drop in their income when his overtime was cut because of the economic downtown. Finding himself £900 worse off a month, the construction worker approached Lloyds for help paying back a debt of £350.
“I was told there was nothing they could do for me. They told me it had to be ‘critical’ before they would help me,” he said.
Source: The Times
Saturday, 11 April 2009
Barclays faces tough iShares questions
Barclays is likely to face more tough questions from shareholders over its decision to sell iShares after the buyer said it would look to float the exchange-traded funds business as soon as stock markets recovered.
CVC Capital Partners, the private equity group that has agreed to buy iShares for $4.2bn (£2.9bn), said it would be a good candidate for a stock market initial public offering. The highly profitable business is the world's top provider of exchange-traded funds, which allow investors to track share indices.
Jonathan Feuer, head of CVC's new financial services team, said: "As a market leading company with attractive growth potential, it is a very attractive flotation candidate . . . people that invest in shares are likely to want to invest in iShares too."
The iShares sale will help Barclays shore up its balance sheet and avoid turning to the UK government for capital. Barclays' shares rose 12.5 per cent to 177½p on Thursday's announcement of the deal amid a broad rally in banking stocks. The bank's shares have risen three-fold since their January lows.
Investors may grumble that the bank is hurriedly selling one of its best assets at a depressed price, especially if CVC floats iShares quickly for a big profit.
Bob Diamond, Barclays' president, is set to pocket $6.9m in cash from the sale of iShares.
As head of Barclays Global Investors, the bank's fund management division, Mr Diamond is one of the beneficiaries of a compensation scheme that has given BGI employees shares and options over as much as 10.3 per cent of the division's equity.
BGI is expected to distribute the cash from the sale to its shareholders in the form of a dividend. Barclays stressed that Mr Diamond was not involved in the iShares sale negotiations. The deal values iShares at about 10 times its pre-tax profits of £288m in 2008.
The business increased assets under management by 10 per cent to £226bn last year, even as BGI's assets fell. Barclays' directors are up for re-election at the bank's annual meeting this month. Some big shareholders have expressed frustration over the board's decision last year to raise £7bn of expensive funds from Middle Eastern investors.
Source: FT
CVC Capital Partners, the private equity group that has agreed to buy iShares for $4.2bn (£2.9bn), said it would be a good candidate for a stock market initial public offering. The highly profitable business is the world's top provider of exchange-traded funds, which allow investors to track share indices.
Jonathan Feuer, head of CVC's new financial services team, said: "As a market leading company with attractive growth potential, it is a very attractive flotation candidate . . . people that invest in shares are likely to want to invest in iShares too."
The iShares sale will help Barclays shore up its balance sheet and avoid turning to the UK government for capital. Barclays' shares rose 12.5 per cent to 177½p on Thursday's announcement of the deal amid a broad rally in banking stocks. The bank's shares have risen three-fold since their January lows.
Investors may grumble that the bank is hurriedly selling one of its best assets at a depressed price, especially if CVC floats iShares quickly for a big profit.
Bob Diamond, Barclays' president, is set to pocket $6.9m in cash from the sale of iShares.
As head of Barclays Global Investors, the bank's fund management division, Mr Diamond is one of the beneficiaries of a compensation scheme that has given BGI employees shares and options over as much as 10.3 per cent of the division's equity.
BGI is expected to distribute the cash from the sale to its shareholders in the form of a dividend. Barclays stressed that Mr Diamond was not involved in the iShares sale negotiations. The deal values iShares at about 10 times its pre-tax profits of £288m in 2008.
The business increased assets under management by 10 per cent to £226bn last year, even as BGI's assets fell. Barclays' directors are up for re-election at the bank's annual meeting this month. Some big shareholders have expressed frustration over the board's decision last year to raise £7bn of expensive funds from Middle Eastern investors.
Source: FT
Robert Reich: Why We're Not at the Beginning of the End, and Probably Not Even At the End of the Beginning
Nice article by Robert Reich who severed as Labour Secretary under Bill Clinton until 1997.***************************************
Are we at the beginning of the end? Mortgage interests are now so low (the average rate on 30-year fixed mortgages was 4.87 percent Thursday, slightly higher than the 4.78 percent last week, but still the lowest level since 1971) that President Obama has begun urging Americans to refinance their homes so they can save money and start spending again. Presidential aide Larry Summers says the country is likely to see positive economic signs in the next few months. Wells Fargo Bank rallied stocks and surprised analysts Thursday when it predicted a strong $3 billion first-quarter profit, citing surging mortgage originations. And executives at the nation's biggest three banks -- JPMorgan Chase, Bank of America, and Citigroup -- say their operations were (at least by some measures) profitable in the first two months of this year, mainly because a resurgent debt market and equity trading lifted earnings in the investment banking divisions.
But we're not at the beginning of the end. I'm not even sure we're at the end of the beginning. All of these pieces of upbeat news are connected by one fact: the flood of money the Fed has been releasing into the economy. Of course mortage rates are declining, mortgage orginations are surging, and people and companies are borrowing more. So much money is sloshing around the economy that its price is bound to drop. And cheap money is bound to induce some borrowing. The real question is whether this means an economic turnaround. The answer is it doesn't.
Cheap money, you may remember, got us into this mess. Six years ago, the Fed (Alan Greenspan et al) lowered interest rates to 1 percent. Adjusted for inflation, this made money essentially free to large lenders. The large lenders did exactly what they could be expected to do with free money -- get as much of it as possible and then lent it out to anyone who could stand up straight (and many who couldn't). With no regulators looking over their shoulders, they got away with the financial equivalent of murder.
The only economic fundamental that's changed since then is that so many people got so badly burned that the trust necessary for consumers, investors, and businesses to repeat what they did then has vanished. Yes, banks will lend to highly trustworthy borrowers, and the low-hanging fruit of highly trustworthy borrowers is the first they'll pick. But there's not much of this kind of fruit to go around. And yes, some consumers will refinance and use the extra money they extract from their homes to spend again. But most will use the extra money to pay off debt and start saving again, as they did years ago. Most consumers continue to worry about their jobs, and for good reason.
Some of the big banks will claim to be profitable, but don't bank on it. Neither they nor anyone else knows what their assets are really worth. Besides, the big banks are sitting on over $500 billion over taxpayer equity and loans. Who knows how they're calculating profits? Most importantly, there's still a yawning gap between the economy's productive capacity and what it's now producing, and absolutely nothing will turn the economy around until that gap begins to close.
I spent the better part of an hour yesterday evening debating Larry Kudlow on his CNBC program, along with Arthur Laffer and two other financial analysts, all of whom were sure that the stock market had hit bottom and was now poised for a major recovery. I admire cockeyed optimism, and I understand why Wall Street and its spokespeople want to see a return of the bull market. Hell, everyone with a stock portfolio wants to see it grow again. But wishing for something is different from getting it. And cockeyed optimism can wreak enormous damage on an economy. Haven't we already learned this?
Source: Robert Reich
Friday, 10 April 2009
Gerald Celente Radio Interview (09-04-2009)
Gerald Celente discusses the economy on the Jeff Rense Program.
Part 1 (10min)
Part 2 (10min)
Part 3 (10min)
Part 4 (10min)
Part 1 (10min)
Part 2 (10min)
Part 3 (10min)
Part 4 (10min)
William K. Black Criticizes the Bailout Plan
William K. Black, professor of Law and Economics at the University of Missouri and author of "The Best Way to Rob a Bank is to Own One" discusses his criticism of Tim Geithner's bank rescue plan.
Thursday, 9 April 2009
How to Lose Your Shirt in Banking
The study out of Harvard and Princeton arguing against the official story line about firesales underpricing toxic assets is now coming under fire from those who think the authors are too pessimistic about asset values.
Megan McArdle at the Atlantic's Business blog raises two objections.
If toxic assets aren't underpriced, we're all in "big, big, BIG trouble."
The market prices for toxic assets don't reflect reasonable expectations of cash flows.
Her first objection isn't really so much an argument as a lament. The correct response is simply: Yes. We are in big trouble. Some of our big money center banks are insolvent. But just because something is very bad news doesn't mean it isn't true.
The second objection is more substantive. We hear a different version of it all the time: real estate isn't going to zero, so therefore securities backed by real estate can't go to zero. This makes sense only if you don't really understand how complex the collateralized debt market got during the boom years. Because once you understand this, it's pretty obvious that even though most mortgages will continue to perform, lots of real-estate based assets held by banks can go to zero.
How To Make An Asset Backed Security
Let's ilustrate this with an example of an asset backed security built on home loans. (We're borrowing the example from the excellent Acrued Interest blog.) These weren't exotic credit products. In fact, for most of the years building up to the crash, HEL ABS (as they were known in the business) was the dominant credit product. In 2005, something like $400 billion were issued. At the time, JP Morgan Chase was urging clients to buy this stuff by saying the pricing was "cheap" because of "irrational fears" over a housing bubble.
So let's say our imaginary bank, CitiMorganAmerica, decides it wants to sell HEL ABS built from mortgages with $100 million face value. One of the first things it does is cut this up into tranches to reflect the risk and price points of various customers. For simplicities sake, we'll just pretend that there are only three tranches. (In reality, there could be dozens of tranches).
Senior: 5.75% coupon, $80 million
Mezzanine: 6.50% coupon, $15 million
Subordinate: 8.00% coupon, $5 million
The reason the lower tranches get bigger coupons is that they are riskier. They only receive interest payments after the tranche above them have received all interst payments they are due. Each tranche below senior receives principal payments only when the tranche above them has been full paid off. Any short fall hits the lowest level first.
Here's where things start to get scary. If just 5% of the mortgages in that HEL ABS default, the subordinate tranche is worth zero. We're just about at 5% national default rate for all mortgages right now. Default rates on more recent mortgages are even higher. Fortunately, the ratings agencies were pretty good about this level of stuff so the Mezz and Sub investors knew they were getting riskier products, and only the senior deal would be rated AAA.
How To Make A CDO
Now lets see what happens when we build a CDO on these types of deals. CitiMorgan America takes $1 billion and buys the Mezz and Sub tranches of 50 HEL ABS deals that are built just like this. It slices up the CDO just like it did the earlier deal.
Senior: 5.45% coupon, $800 million
Mezz: 6.00% coupon, $120 million
Sub: 8.00% coupon, $40 million
Equity: $40 million
These pay out just like the ABS, a waterfall filling up each bucket before anything gets paid to the next level down. The top tranche of this CDO can be rated AAA even though it is built out of already subordinated debt. You see, even though it is technically subordinated debt, there are so many underlying mortgages spread out across the country that the odds of systemic defaults materially affecting the cash flow would have been viewed very remote. After all, what are the odds that defaults will suddenly tick up all around the country?
How To Lose Your Shirt
See the problem? Here you have $1 billion of assets that can be devastated by a small increase in the default rate. If defaults climb to just 5% for the underlying mortgages, the cash flows will drop 25% as the portion of the CDO built from the Sub HEL ABS stops paying. Everything but the senior portion of the CDO gets wiped out.
If the losses on the mortgages rise to just 10%--high defaults from those bubble years from 2005, lower than expected recovery rates from foreclosures on houses with falling values, cram downs--even the most senior piece will lose 30% of its value.
In short, structured debt can rapidly decline in value even though the underlying assets don't decline as much. The benchmark index of the market for securities backed by home loans shows that the AAA tranches for deals made in 2007 are valued at about 23% of their original value. The lower tranches show losses greater than 97%. Some of this may no doubt reflect a bit of irrational fear and illiquidity. But claiming the overwhelming majority of these losses aren't real is just wishful thinking.
Source: Business Insider
Megan McArdle at the Atlantic's Business blog raises two objections.
If toxic assets aren't underpriced, we're all in "big, big, BIG trouble."
The market prices for toxic assets don't reflect reasonable expectations of cash flows.
Her first objection isn't really so much an argument as a lament. The correct response is simply: Yes. We are in big trouble. Some of our big money center banks are insolvent. But just because something is very bad news doesn't mean it isn't true.
The second objection is more substantive. We hear a different version of it all the time: real estate isn't going to zero, so therefore securities backed by real estate can't go to zero. This makes sense only if you don't really understand how complex the collateralized debt market got during the boom years. Because once you understand this, it's pretty obvious that even though most mortgages will continue to perform, lots of real-estate based assets held by banks can go to zero.
How To Make An Asset Backed Security
Let's ilustrate this with an example of an asset backed security built on home loans. (We're borrowing the example from the excellent Acrued Interest blog.) These weren't exotic credit products. In fact, for most of the years building up to the crash, HEL ABS (as they were known in the business) was the dominant credit product. In 2005, something like $400 billion were issued. At the time, JP Morgan Chase was urging clients to buy this stuff by saying the pricing was "cheap" because of "irrational fears" over a housing bubble.
So let's say our imaginary bank, CitiMorganAmerica, decides it wants to sell HEL ABS built from mortgages with $100 million face value. One of the first things it does is cut this up into tranches to reflect the risk and price points of various customers. For simplicities sake, we'll just pretend that there are only three tranches. (In reality, there could be dozens of tranches).
Senior: 5.75% coupon, $80 million
Mezzanine: 6.50% coupon, $15 million
Subordinate: 8.00% coupon, $5 million
The reason the lower tranches get bigger coupons is that they are riskier. They only receive interest payments after the tranche above them have received all interst payments they are due. Each tranche below senior receives principal payments only when the tranche above them has been full paid off. Any short fall hits the lowest level first.
Here's where things start to get scary. If just 5% of the mortgages in that HEL ABS default, the subordinate tranche is worth zero. We're just about at 5% national default rate for all mortgages right now. Default rates on more recent mortgages are even higher. Fortunately, the ratings agencies were pretty good about this level of stuff so the Mezz and Sub investors knew they were getting riskier products, and only the senior deal would be rated AAA.
How To Make A CDO
Now lets see what happens when we build a CDO on these types of deals. CitiMorgan America takes $1 billion and buys the Mezz and Sub tranches of 50 HEL ABS deals that are built just like this. It slices up the CDO just like it did the earlier deal.
Senior: 5.45% coupon, $800 million
Mezz: 6.00% coupon, $120 million
Sub: 8.00% coupon, $40 million
Equity: $40 million
These pay out just like the ABS, a waterfall filling up each bucket before anything gets paid to the next level down. The top tranche of this CDO can be rated AAA even though it is built out of already subordinated debt. You see, even though it is technically subordinated debt, there are so many underlying mortgages spread out across the country that the odds of systemic defaults materially affecting the cash flow would have been viewed very remote. After all, what are the odds that defaults will suddenly tick up all around the country?
How To Lose Your Shirt
See the problem? Here you have $1 billion of assets that can be devastated by a small increase in the default rate. If defaults climb to just 5% for the underlying mortgages, the cash flows will drop 25% as the portion of the CDO built from the Sub HEL ABS stops paying. Everything but the senior portion of the CDO gets wiped out.
If the losses on the mortgages rise to just 10%--high defaults from those bubble years from 2005, lower than expected recovery rates from foreclosures on houses with falling values, cram downs--even the most senior piece will lose 30% of its value.
In short, structured debt can rapidly decline in value even though the underlying assets don't decline as much. The benchmark index of the market for securities backed by home loans shows that the AAA tranches for deals made in 2007 are valued at about 23% of their original value. The lower tranches show losses greater than 97%. Some of this may no doubt reflect a bit of irrational fear and illiquidity. But claiming the overwhelming majority of these losses aren't real is just wishful thinking.
Source: Business Insider
Wednesday, 8 April 2009
Willem Buiter: "Non-Negligible" Risk of Default by US and UK
Willem Buiter takes no prisoners, In his latest post, "The green shoots are weeds growing through the rubble in the ruins of the global economy", he dispatches the idea that recovery is around the corner (citing Carmen Reinhart and Kenneth's latest paper on the resolution of financial crises) and points out that the fiscal state of affairs in the US and UK will become sufficiently strained (even making the usual allowances for Keynesian stimulus) so as to make default a possibility (but recognize that Buiter is not saying it is likely). The easiest way to default, however is via inflation, but that also has the nasty side effect of "taxing" all domestic savers, not just the unfortunates who owned government paper. So the fact that Buiter even mentions explicit default is telling.
Buiter also believes that the imbalanced nature of stimulus measures – more than is optimal from countries under financial stress like the US and UK, too little from countries with balance of payment surpluses (China, Japan, Germany) means growth once the acute phase of the crisis is past will be lower than it would be with a better response. He is also critical of the Fed's version of quantitative easing and is dubious that the commitments at the G20 to provide $1 trillion to the IMF will come through.
He also, in passing, says (without mentioning his name) that Simon Johnsom may be correct in his view that the government is captured by the finance sector, not merely by subscribing to their world view, as he has argued before, but in the mercenary sense.
From Buiter:
Willem Buiter
Source: Naked Capitalism
Buiter also believes that the imbalanced nature of stimulus measures – more than is optimal from countries under financial stress like the US and UK, too little from countries with balance of payment surpluses (China, Japan, Germany) means growth once the acute phase of the crisis is past will be lower than it would be with a better response. He is also critical of the Fed's version of quantitative easing and is dubious that the commitments at the G20 to provide $1 trillion to the IMF will come through.
He also, in passing, says (without mentioning his name) that Simon Johnsom may be correct in his view that the government is captured by the finance sector, not merely by subscribing to their world view, as he has argued before, but in the mercenary sense.
From Buiter:
Willem Buiter
Source: Naked Capitalism
Tuesday, 7 April 2009
George Soros warns 'zombie' banks could suck lifeblood out of economy
Billionaire investor George Soros has warned that bailing out banks could turn them into "zombies" that suck the lifeblood of the American economy, which he predicted is in for a "lasting slowdown".
He also cautioned that the recent rise in global stockmarkets is a "bear market rally because we have not yet turned the economy around".
His gloomy verdict weighed on Asian stockmarkets today, alongside a report that the International Monetary Fund now estimates that the toxic debts racked up by banks and insurers could spiral to $4tn (£2.7tn).
Tokyo's Nikkei index edged down 0.3% to 8832.85 while Hong Kong's Hang Seng fell 1.1% and Singapore's Straits Times index was down 2.1%. However, the FTSE 100 index in London rose 33 points to 4027.15 in early trading.
Soros said he does not expect the US economy to recover until next year at the earliest.
"The recovery will look like an inverted square root sign," he said. "You hit bottom and you automatically rebound some, but then you don't come out of it in a V-shaped recovery or anything like that. You settle down, step down."
His comments last night came after Morgan Stanley warned the bear market was not over. Its much followed strategy team led by Teun Draaisma moved its recommendation on equities from neutral to underweight.
The team said in a note yesterday: ""We have to decide whether this is towards the end of another bear market rally that we should sell into now that hope has grown, or the start of a much larger advance, maybe even a new bull market. Our decision is to sell into strength now."
Soros stressed that restoring health to the "basically insolvent" banking system and the housing market is key to any recovery. The public-private investment funds introduced to rid US banks of bad debts will work but won't be enough to recapitalise the banks so they can start lending again, he said.
"What we have created now is a situation where the banks will be able to earn their way out of a hole but by doing that, they are going to weigh on the economy," Soros said. "Instead of stimulating the economy, they will draw the lifeblood, so to speak, of profits away from the real economy in order to keep themselves alive."
Analysts agreed that the financial system remains a problem and thought recent optimism that the worst may be over was overdone.
"The market's stance on banks had been too optimistic recently," said Nagayuki Yamagishi, a strategist at Mitsubishi Securities in Tokyo. "Some large US banks have already passed stress tests, but others haven't, and given that results are coming up soon, this simply reignited investor uncertainty."
Source: Guardian
He also cautioned that the recent rise in global stockmarkets is a "bear market rally because we have not yet turned the economy around".
His gloomy verdict weighed on Asian stockmarkets today, alongside a report that the International Monetary Fund now estimates that the toxic debts racked up by banks and insurers could spiral to $4tn (£2.7tn).
Tokyo's Nikkei index edged down 0.3% to 8832.85 while Hong Kong's Hang Seng fell 1.1% and Singapore's Straits Times index was down 2.1%. However, the FTSE 100 index in London rose 33 points to 4027.15 in early trading.
Soros said he does not expect the US economy to recover until next year at the earliest.
"The recovery will look like an inverted square root sign," he said. "You hit bottom and you automatically rebound some, but then you don't come out of it in a V-shaped recovery or anything like that. You settle down, step down."
His comments last night came after Morgan Stanley warned the bear market was not over. Its much followed strategy team led by Teun Draaisma moved its recommendation on equities from neutral to underweight.
The team said in a note yesterday: ""We have to decide whether this is towards the end of another bear market rally that we should sell into now that hope has grown, or the start of a much larger advance, maybe even a new bull market. Our decision is to sell into strength now."
Soros stressed that restoring health to the "basically insolvent" banking system and the housing market is key to any recovery. The public-private investment funds introduced to rid US banks of bad debts will work but won't be enough to recapitalise the banks so they can start lending again, he said.
"What we have created now is a situation where the banks will be able to earn their way out of a hole but by doing that, they are going to weigh on the economy," Soros said. "Instead of stimulating the economy, they will draw the lifeblood, so to speak, of profits away from the real economy in order to keep themselves alive."
Analysts agreed that the financial system remains a problem and thought recent optimism that the worst may be over was overdone.
"The market's stance on banks had been too optimistic recently," said Nagayuki Yamagishi, a strategist at Mitsubishi Securities in Tokyo. "Some large US banks have already passed stress tests, but others haven't, and given that results are coming up soon, this simply reignited investor uncertainty."
Source: Guardian
Monday, 6 April 2009
The Best Way to Rob a Bank: Own One!
The financial industry brought the economy to its knees, but how did they get away with it? With the nation wondering how to hold the bankers accountable, Bill Moyers sits down with William K. Black, the former senior regulator who cracked down on banks during the savings and loan crisis of the 1980s. Black offers his analysis of what went wrong and his critique of the bailout
PM's Just Saved Apocalypse for Later
HALLELUJAH! Gordon’s saved the world. But what about Britain?To be fair, the Prime Minister pulled off a brilliant propaganda coup — and delivered real help for stricken economies around the world.
The good news is that bankrupt countries in Eastern Europe will not go bust or — more importantly — drag everyone else down with them.
That’s because the International Monetary Fund — the world’s pawn shop — can now print its own money and bail out basket-case economies such as Hungary.
“So, no Apocalypse Now,” says my City analyst.
The bad news is that Britain looks like becoming one of those basket cases.
Taking a begging bowl to the IMF would be a grotesque humiliation for a nation so recently rated as the world’s fourth-largest economy.
Yet in perhaps his most outrageous spin operation ever, Prince of Darkness Peter Mandelson is already smoothing the path.
Britain is not “head of the queue” for IMF money, he told C4 News. But there would be “no stigma” for Britain if we were.
An unnamed minister, who must surely be Mandy, later told a newspaper: “Previously, a country would only go to the IMF if they were in a very bad state. It was a bit like going to Accident and Emergency to get urgent help. This new facility is like getting wellbeing care or going to a spa to recuperate.”
Before you swallow that nonsense, listen to Simon Johnson, the IMF’s former chief economist.
“With all due respect to Gordon Brown and his ministers, they need some help right now,” he told the same C4 programme.
“Your economy — the UK economy — is in big trouble.”
Who do you believe?
I don’t want to rain on Gordon Brown’s parade, but I lean towards Mr Johnson — things are going to get much worse before they get any better.
My “Apocalypse Deferred” City source sees big trouble ahead. Any “green shoots” risk turning sickly yellow under the pall of national debt.
“The IMF is right,” he says. “The UK economy is in trouble and to suggest America is to blame is just daft.
“We are borrowing massively, printing money. We have a higher household debt ratio than America and rely more than anyone else on financial services, which are in trouble.
“As a result, Sterling is a risky currency.
“Big investors looking for safe havens for their clients’ billions are worried about the Pound. If they switch to another currency, Britain is in trouble.
“There is a 25-per-cent chance of a run on the Pound in the next six months. That’s a shockingly high probability.”
Some optimists say America will start recovering next year — but not debt-laden Britain.
After his G20 triumph, the Prime Minister will be pleased by a three-per-cent bounce in share prices — and in Labour’s poll ratings.
He will also welcome dodgy claims that house prices are rising again. All three are likely to be “blips”.
Indeed, the Halifax have already trashed the evidence of a housing revival, with figures showing a 1.9 per cent FALL in prices last month.
In a remarkable outburst of candour, Chancellor Alistair Darling blames predecessor Gordon Brown for castrating the watchdogs who might have saved our banks.
Now, on the eve of this month’s crucial Budget, he warns we are nowhere near recovery.
“It’s worse than we thought,” he says.
Mr Darling says the economy will shrink in its worst performance since World War II. Unemployment will keep soaring — perhaps even doubling to 4million.
Asked if there was any reason for cheer, the Chancellor confessed: “There is some way to go yet.
“We have to be realistic. You cannot — you must not — build up false hope.”
This bleak scenario is a million miles from the PM’s beaming optimism.
As the G20 packed up, he claimed a “new world order”, backed by a mythical trillion dollars in spending money. Don’t believe it. As Chancellor, Gordon Brown was famous for his thimble-and-pea tricks.
As in so many of his smoke-and-mirror budgets, these numbers simply don’t add up.
FRANCE and Germany were pleased with their G20 pincer attack on the “Anglo-Saxon economies” – Britain and America.
Pint-sized egotist Nicolas Sarkozy resents popular Barack Obama almost as much as he does First Lady Michelle for eclipsing his wife Carla Bruni.
America will ignore him. But he and Germany’s Angela Merkel have forced concessions out of Britain on the way we do business.
In return for his “triumph” last week, just how many economic levers has Mr Brown surrendered to Brussels?
Source: TREVOR KAVANAGH
Friday, 3 April 2009
Thursday, 2 April 2009
Collapsing Commercial Real Estate Could Snuff out Economic Recovery
Stock prices have rallied for much of last month. The housing market has shown some early signs of life. And some of the latest economic reports haven't been the disasters that many experts feared.
While this is hardly a portrait of an economy on a roll, there are enough bright spots to nurture a feeling that the U.S. economy is finally on a path to recovery - especially given the upbeat response the latest elements of the Obama administration's fix-it plans have received.
But there's a dark cloud in this picture. And it's big - big enough, in fact, to potentially finish off the U.S. banking sector, blotting out the U.S. economy's new dawn.
That dark cloud is the commercial real estate sector. With rent prices falling and vacancies rising due to the recession-weakened economy, delinquencies on commercial mortgages are already escalating steeply. And the credit crunch bred from the recession is often making it impossible for property owners to avoid deeper trouble by refinancing.
"It's a one-two punch combination: First, soaring vacancies take the wind out of positive cash flow; then the credit crisis hits like a rabbit punch, snapping off the main arteries to refinancing," says Money Morning Contributing Editor Shah Gilani, a retired hedge-fund manager and expert on the U.S. credit crisis who predicted the implosion of the commercial real estate sector several years ago. "This is like Samson hitting the ground. The giant asset class we call commercial real estate is not going to get up any time soon."
Here in the U.S. market, commercial real estate is worth about $6.5 trillion, and is financed by an estimated $3.1 trillion in debt.
And that debt is going bad at an escalating rate. In March, the delinquency rate on about $724 billion in securitized debt reached 1.8%. As percentages go, that's a pretty small number. In fact, it's less than a quarter of the housing market's record-breaking mortgage-delinquency rate of 7.88% for the fourth quarter , according to the Mortgage Banker's Association.
But don't let that 1.8% rate fool you: The delinquency rate on commercial-real-estate debt has more than doubled just since September, according to a new Deutsche Bank AG ( DB ) report called " Commercial Real Estate at the Precipice ."
With that increase, experts say the delinquency rate on commercial real estate has already almost equaled the rate achieved during the last U.S. economic slump, which took place at the beginning of this decade. And forecasts now call for the current downturn in the commercial real estate market to rival - and perhaps even exceed - the plunge of the early 1990s, when nearly 8% of all commercial real estate loans went sour. Banks and thrifts took nearly $50 billion in charges, and nearly 1,000 lenders failed, The Wall Street Journal said.
The fallout this time could be much worse - for three key reasons:
Commercial Real Estate is a Heavyweight Sector : Although soaring defaults on student loans, auto loans or credit cards certainly won't help a nascent economic recovery, those slices of the debt market are dwarfed by their commercial real estate counterpart. What's more, the $3.1 trillion that makes up the commercial real estate debt market is three times the size it was during the early 1990s - meaning the potential for losses is steeper than ever before.
Commercial Real Estate is Closely Tied to Employment : The second factor is jobs. In the housing market, a loan default essentially affects a single family. In commercial real estate, a default typically signifies big problems at the company that owns or occupies the building or property that the loan finances. And those "big problems" typically translate into reduced jobs. This is debt that's backed by the mostly vacant downtown high-rise where your neighbor worked before his employer downsized; by the neighborhood mall that shoppers avoid after it lost its Starbucks ( SBUX ), Circuit City (OTC: CCTYQ ), Linens ‘N Things and Mervyns retail locations; or by a factory of a now-bankrupt supplier of parts for the General Motors Corp. ( GM ) passenger car that's been cancelled.
A Nosedive in the Commercial Real Estate Sector Could Torpedo any Improvements the American Banking Sector Has Seen : Since 2007, 47 lenders have failed, of which one quarter had an exceptionally high exposure to commercial real estate loans. Until recently, the U.S. banking sector has been an economic "black hole," whose unending appetite for capital left nothing for actual economic stimulus efforts. That black-hole syndrome seemed to have been resolved recently, allowing the Obama administration to enact other stimulus plans. But many experts fear that a severe downturn in the commercial real estate sector might be enough to reopen this interstellar capital chasm, blunting all other rebound initiatives. Foresight Analytics LLC estimates that - as a result of the ongoing downturn - the U.S. banking sector could incur as much as $250 billion in commercial real estate losses, enough to cause another 700 banks to fail.
" Any bank that has a sizable book of commercial real estate loans could have serious problems in 2009 ," Jamie Peters, a bank analyst at Morningstar Inc . in Chicago, told The Minneapolis Star-Tribune .
This time around - compared to the early 1990s - banks left themselves no margin of safety in the form of " Tier I Capital " - a measure of how well a lender can navigate serious levels of losses. The higher the ratio, the less likely a lender will be able to work its way through a stretch when loans start going bad.
In 1993, less than 2% of U.S. banks and thrifts had an exposure to commercial real estate that was more than five times their Tier I capital. By the end of last year, that ratio had spiked to 12%, involving about 800 banks and thrifts.
As Money Morning reported, the U.S. Treasury Department and the U.S. Federal Reserve are working on a program that would induce private investors to buy into debt backed by such income-producing commercial properties as office buildings, retail stores and hotels. The program - the Term Asset-Backed Securities Loan Facility (TALF) - is seen as a way of breaking the toxic-asset logjam , and to bring capital to debt that can't be refinanced because of the ongoing credit crisis.
This is an attempt to avoid the [dangerous] "repeat of what happened on the residential side: A complete choking up, foreclosure disasters and increased stress on the banking system," Jeffrey DeBoer, chief executive of the Real Estate Roundtable, told The Journal .
What has real estate executives really worried is the looming surge in commercial real estate loans coming due. Until now, delinquencies on commercial real estate loans have stayed below historical levels (due mostly to the limited amount of speculative construction that's taken place in recent years. But delinquencies are now surging - in a big way - just as the volume of loans coming due is also spiking - and just as the few remaining lenders willing to make the kind of loans needed to refinance this debt are exiting the market.
"The credit crisis has got so bad that refinancing of even good loans may be drying up," says Richard Parkus, head of commercial-mortgage-backed securities research at Deutsche Bank, and the author of the afore-mentioned "Commercial Real Estate at the Precipice" report.
Commercial real estate loans differ from their residential-loan counterparts, which borrowers repay after a set period of time - usually 30 years. Commercial mortgages usually are underwritten for five, seven or 10 years with big "balloon" payments due at the very end. At that point, the property owner usually turns the loan over and refinances it. A borrower's inability to refinance could force it to default.
All of a sudden, scores of experts are warning federal lawmakers that hundreds - or even thousands - of resort hotels, retail malls and shopping center properties and commercial complexes of all sorts are headed for, on the verge of, or are already in default, a Memphis Daily News report stated. The reason: About $530 billion of commercial mortgages will be coming due for refinancing in 2009-2011 - with about $160 billion maturing this year - even as credit for refinancing remains non-existent, and cash flows from rents and leases are way down due to the recession, property researcher Foresight Analytics concluded.
What's not clear is how soon the crunch will come - or if it will come at all.
The Real Estate Roundtable, a key trade group for the industry, late last year predicted that more than $400 billion of commercial mortgages will come due through the end of 2009. Foresight Analytics estimates that $160 billion of commercial mortgages will mature next year.
"Unfortunately, the commercial real estate market is even more vulnerable to economic cycles, and here I'm talking about deep recession, than residential real estate," Money Morning 's Gilani says.
The current recession - which started in December 2007 - could be the wild card, Gilani says. If the U.S. economy continues to improve, as it seems to be, and as many experts predict will continue to, cash flows from properties won't keep declining, and defaults won't escalate. Unfortunately, there's an inertia that takes hold during a downturn: Companies continue to slash jobs, shutter plants, close stores and otherwise cut expenses - often even after the broader economy shows early signs of new life. This inertia could be enough to keep commercial real estate vacancies to rise and defaults to escalate.
If that happens, it's possible the commercial real estate sector becomes the "tipping point" that could keep the U.S. economy ensconced in its current recession, or if the recovery is truly under way, push the U.S. market into a "double-dip" downturn.
Time will clearly tell.
Source: Shah Galani @ Money Morning
While this is hardly a portrait of an economy on a roll, there are enough bright spots to nurture a feeling that the U.S. economy is finally on a path to recovery - especially given the upbeat response the latest elements of the Obama administration's fix-it plans have received.
But there's a dark cloud in this picture. And it's big - big enough, in fact, to potentially finish off the U.S. banking sector, blotting out the U.S. economy's new dawn.
That dark cloud is the commercial real estate sector. With rent prices falling and vacancies rising due to the recession-weakened economy, delinquencies on commercial mortgages are already escalating steeply. And the credit crunch bred from the recession is often making it impossible for property owners to avoid deeper trouble by refinancing.
"It's a one-two punch combination: First, soaring vacancies take the wind out of positive cash flow; then the credit crisis hits like a rabbit punch, snapping off the main arteries to refinancing," says Money Morning Contributing Editor Shah Gilani, a retired hedge-fund manager and expert on the U.S. credit crisis who predicted the implosion of the commercial real estate sector several years ago. "This is like Samson hitting the ground. The giant asset class we call commercial real estate is not going to get up any time soon."
Here in the U.S. market, commercial real estate is worth about $6.5 trillion, and is financed by an estimated $3.1 trillion in debt.
And that debt is going bad at an escalating rate. In March, the delinquency rate on about $724 billion in securitized debt reached 1.8%. As percentages go, that's a pretty small number. In fact, it's less than a quarter of the housing market's record-breaking mortgage-delinquency rate of 7.88% for the fourth quarter , according to the Mortgage Banker's Association.
But don't let that 1.8% rate fool you: The delinquency rate on commercial-real-estate debt has more than doubled just since September, according to a new Deutsche Bank AG ( DB ) report called " Commercial Real Estate at the Precipice ."
With that increase, experts say the delinquency rate on commercial real estate has already almost equaled the rate achieved during the last U.S. economic slump, which took place at the beginning of this decade. And forecasts now call for the current downturn in the commercial real estate market to rival - and perhaps even exceed - the plunge of the early 1990s, when nearly 8% of all commercial real estate loans went sour. Banks and thrifts took nearly $50 billion in charges, and nearly 1,000 lenders failed, The Wall Street Journal said.
The fallout this time could be much worse - for three key reasons:
Commercial Real Estate is a Heavyweight Sector : Although soaring defaults on student loans, auto loans or credit cards certainly won't help a nascent economic recovery, those slices of the debt market are dwarfed by their commercial real estate counterpart. What's more, the $3.1 trillion that makes up the commercial real estate debt market is three times the size it was during the early 1990s - meaning the potential for losses is steeper than ever before.
Commercial Real Estate is Closely Tied to Employment : The second factor is jobs. In the housing market, a loan default essentially affects a single family. In commercial real estate, a default typically signifies big problems at the company that owns or occupies the building or property that the loan finances. And those "big problems" typically translate into reduced jobs. This is debt that's backed by the mostly vacant downtown high-rise where your neighbor worked before his employer downsized; by the neighborhood mall that shoppers avoid after it lost its Starbucks ( SBUX ), Circuit City (OTC: CCTYQ ), Linens ‘N Things and Mervyns retail locations; or by a factory of a now-bankrupt supplier of parts for the General Motors Corp. ( GM ) passenger car that's been cancelled.
A Nosedive in the Commercial Real Estate Sector Could Torpedo any Improvements the American Banking Sector Has Seen : Since 2007, 47 lenders have failed, of which one quarter had an exceptionally high exposure to commercial real estate loans. Until recently, the U.S. banking sector has been an economic "black hole," whose unending appetite for capital left nothing for actual economic stimulus efforts. That black-hole syndrome seemed to have been resolved recently, allowing the Obama administration to enact other stimulus plans. But many experts fear that a severe downturn in the commercial real estate sector might be enough to reopen this interstellar capital chasm, blunting all other rebound initiatives. Foresight Analytics LLC estimates that - as a result of the ongoing downturn - the U.S. banking sector could incur as much as $250 billion in commercial real estate losses, enough to cause another 700 banks to fail.
" Any bank that has a sizable book of commercial real estate loans could have serious problems in 2009 ," Jamie Peters, a bank analyst at Morningstar Inc . in Chicago, told The Minneapolis Star-Tribune .
This time around - compared to the early 1990s - banks left themselves no margin of safety in the form of " Tier I Capital " - a measure of how well a lender can navigate serious levels of losses. The higher the ratio, the less likely a lender will be able to work its way through a stretch when loans start going bad.
In 1993, less than 2% of U.S. banks and thrifts had an exposure to commercial real estate that was more than five times their Tier I capital. By the end of last year, that ratio had spiked to 12%, involving about 800 banks and thrifts.
As Money Morning reported, the U.S. Treasury Department and the U.S. Federal Reserve are working on a program that would induce private investors to buy into debt backed by such income-producing commercial properties as office buildings, retail stores and hotels. The program - the Term Asset-Backed Securities Loan Facility (TALF) - is seen as a way of breaking the toxic-asset logjam , and to bring capital to debt that can't be refinanced because of the ongoing credit crisis.
This is an attempt to avoid the [dangerous] "repeat of what happened on the residential side: A complete choking up, foreclosure disasters and increased stress on the banking system," Jeffrey DeBoer, chief executive of the Real Estate Roundtable, told The Journal .
What has real estate executives really worried is the looming surge in commercial real estate loans coming due. Until now, delinquencies on commercial real estate loans have stayed below historical levels (due mostly to the limited amount of speculative construction that's taken place in recent years. But delinquencies are now surging - in a big way - just as the volume of loans coming due is also spiking - and just as the few remaining lenders willing to make the kind of loans needed to refinance this debt are exiting the market.
"The credit crisis has got so bad that refinancing of even good loans may be drying up," says Richard Parkus, head of commercial-mortgage-backed securities research at Deutsche Bank, and the author of the afore-mentioned "Commercial Real Estate at the Precipice" report.
Commercial real estate loans differ from their residential-loan counterparts, which borrowers repay after a set period of time - usually 30 years. Commercial mortgages usually are underwritten for five, seven or 10 years with big "balloon" payments due at the very end. At that point, the property owner usually turns the loan over and refinances it. A borrower's inability to refinance could force it to default.
All of a sudden, scores of experts are warning federal lawmakers that hundreds - or even thousands - of resort hotels, retail malls and shopping center properties and commercial complexes of all sorts are headed for, on the verge of, or are already in default, a Memphis Daily News report stated. The reason: About $530 billion of commercial mortgages will be coming due for refinancing in 2009-2011 - with about $160 billion maturing this year - even as credit for refinancing remains non-existent, and cash flows from rents and leases are way down due to the recession, property researcher Foresight Analytics concluded.
What's not clear is how soon the crunch will come - or if it will come at all.
The Real Estate Roundtable, a key trade group for the industry, late last year predicted that more than $400 billion of commercial mortgages will come due through the end of 2009. Foresight Analytics estimates that $160 billion of commercial mortgages will mature next year.
"Unfortunately, the commercial real estate market is even more vulnerable to economic cycles, and here I'm talking about deep recession, than residential real estate," Money Morning 's Gilani says.
The current recession - which started in December 2007 - could be the wild card, Gilani says. If the U.S. economy continues to improve, as it seems to be, and as many experts predict will continue to, cash flows from properties won't keep declining, and defaults won't escalate. Unfortunately, there's an inertia that takes hold during a downturn: Companies continue to slash jobs, shutter plants, close stores and otherwise cut expenses - often even after the broader economy shows early signs of new life. This inertia could be enough to keep commercial real estate vacancies to rise and defaults to escalate.
If that happens, it's possible the commercial real estate sector becomes the "tipping point" that could keep the U.S. economy ensconced in its current recession, or if the recovery is truly under way, push the U.S. market into a "double-dip" downturn.
Time will clearly tell.
Source: Shah Galani @ Money Morning
Wednesday, 1 April 2009
Bailout Economics: The Politics of Self Destruction
This article, written by Alex Merk, takes the American perspective of Government bailouts. Given that Gordon Brown has gone down the same road, this piece also reflects the situation of the UK as well.
Bailout Economics
Bailout Economics
Tuesday, 31 March 2009
Geithner's ‘Dirty Little Secret' Transfer Trillions to Bankrupt Mega Banks
US Treasury Secretary Tim Geithner has unveiled his long-awaited plan to put the US banking system back in order. In doing so, he has refused to tell the ‘dirty little secret' of the present financial crisis. By refusing to do so, he is trying to save de facto bankrupt US banks that threaten to bring the entire global system down in a new more devastating phase of wealth destruction.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
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