Friday, July 24, 2009

Long TIme No Post

Three and a half months since my last post. Why? Frankly I got tired of it. Tired of being depressed about the state of our economy. Tired of everyone I know telling me things are turning around. Tired of hearing some friends and colleagues attest that the worst is past us and citing CNBC as their source.

But I am tired of it no more. I am angry again. And here is why.

Yesterday I read several headlines from CNBC to AP to Yahoo to even President Obama himself state that things are turning for the better. (some) Banks are making profits again. Existing home sales improved May to June. Companies like Caterpillar are posting upside surprises to their earnings. The stockmarket rocketed past 9000. Jobless claims went from 700k+ per month when Obama took office to 400k per month in June. The recovery is here and in fact it may end up (if they are right) being the shortest recession ever. How amazing! Considering the dire straits we were in just six months ago, our leaders at the Treasury and Federal Reserve have picked us up and we will be walking, no running again soon. I wonder if everybody feels better.

Shouldn't we look at these signs of turnaround a little closer before declaring a turnaround, though?

Take Banks. There are several known (and unknown) direct reasons for their sudden health, but chew on this indirect ultimate cause: The US money supply has DOUBLED in the past one year! The US Government collected 30% less personal and corporate taxes so far this year than last year ($11.13T to $787B), meaning companies and citizens are making less. Read that again: Twice the money supply, but 30% less income. You may be thinking where is all that new money? Doesn't it seem funny (and wrong) that the government hands out lots of free money and suddenly banks are profitable (and paying record bonuses again no less)?

And that doesn't even speak to the inflationary threat from increased money supply. I suspect the only reason we have not seen massive inflation (yet) is that all that new money has not left the banks vaults except in the form of bonuses to the bank executives who have fooled us into thinking they have saved themselves (and us very soon I suppose). One thing is for sure, that new money is definitely not creating any new jobs (more on that below).

I hate to blame Obama because I don't see him as any worse (or better) than any other president. But it is all happening on his watch now, and he actually campaigned on change. Is this any kind of change? What kind of change gives the Federal Reserve even more power than it had before to cover up its constituents' (the banks) bad mistakes? And hurt the common folks in the process? Is that change we can believe in? I am as fair and open as anybody when it comes to considering Obama's goals and actions. But I don't blame Obama as much as to point out that no matter who the president is this situation was allowed to happen.

Then there are all the earnings upticks. Caterpillar (one of many examples) surprised on its earnings yesterday so the market cheered and bid its stock up along with all the other stocks. But look any deeper. They have laid off 17,000 of their workforce (in 2009) with more to come. Their equipment sales were down 49%. Their profits were down 66%. This is a company that is supposed to benefit from the stimulus! Does that look or feel like a recovery?

And jobs. Even I can't deny that first time jobless claims going down by 40% is a good sign, right? Well, official unemployment is at 10% and hasn't slowed its assent, which means those who lost their jobs earlier are not finding work. In fact I read yesterday that there are 6 jobless for evey 1 job available compared to 2 to 1 in April 2008. In fact 6 to 1 is the highest ratio ever since records started being kept in 1949. Is that good news? Doesn't that make the lower new jobless claims number feel a little cheap?

And then there is the housing market. Existing home sales are up from last month. For the third month in a row! (http://news.yahoo.com/s/nm/20090723/ts_nm/us_usa_economy_5) This one is the most foolish reports of them all. It should be a crime to report this data in this fashion. Does it seem honest in light of the chart below? (see that blip up at the end of the red line? that is the three month uptick. Look how many upticks like that since the peak in early 2005).



I hope I have successfully made my point. I cannot understand why all the mainstream press, from Fox to NBC on the spectrum and everything in between feels the need to tow the line. All the reporting is one sided. Our fourth estate has become a cheerleading section. It is irresponsible in my opinion to present the idea to the American people that things are about to get better when most of the data clearly indicates otherwise.

I hate to bring you down if you have bought into the green shoot idea. And I hope I am wrong in my outlook for our economy. But despite being pessimistic about the economy, I am optomistic about our society. I know we can overcome the hard times ahead of us because Americans are the best in the world and banding together to help each other and others. And that hasn't changed. But it is foolish to believe that things are going to turnaround soon until the unemployment rate actually takes a turn for the better, and retail sales start an uptrend. And none of those two things seems imminent in the data I review.

Thanks for your time.

Wednesday, March 25, 2009

Bernanke, Giethner, Obama

I haven't written in awhile because my anger had turned to malaise in watching all the speeches and interviews and actions that the economic leaders of our nation have been putting forth on our behalf. It has taken a long time to read the plans and watch the interviews and review the speech and I have finally started to boil again. My reaction has come down to a single question.

What is their objective?

Now, the answer to that may seem easy if you believe Obama last night. They are looking out for us, the American People. Obama clearly believes that the best thing for us is growth, and he intends use the predicted 2.2 or 2.6 percent growth to pay for not only all the debt we are adding to stimulate the growth, but also for all the new initiatives included in his plan (health care, renewable energy, etc.) which will aslo account for some or most of that growth.

But are they really looking out for us? From the actions, I am not so sure they are not just looking out for the banks. Weather they believe that the banks honestly need to be rescued at any cost, or if they believe armageddon will ensue, or if they are simply worried about losing the power they have attained, I don't know. But clearly their priority is saving the banks (including Wall Street), and the people are secondary.

I am one who believes that any President, be it Bush or Obama or Clinton or Reagan or Carter, genuinely has the best interests of the country at heart. I also believe Obama is a smart man. Last night he was asked about the stimulus and how we are really going to pay for all this. On 60 minutes he was asked if we have reached the limit on how much we can borrow to pay for it. Obama's dodge insisted healthcare reform and green energy will spur growth, but he flipped the question around claiming if we don't spend, we can't grow and the deficit will be even worse.

Huh? Less spending means a higher deficit? Does he REALLY believe that? What on earth are those meetings with Geithner like? Is Volcker in any of these meetings? Obama is a smart man, but if he really believes this, then I wonder what his priorities are.

And then there is AIG. All the outrage in the press, and from Congress, and from the President himself on the bonuses, when not only are the bonuses less than a fraction of a percent of what has been spent on AIG, but all the players have completely lost sight of what is really happening at AIG (or have they?). During all the bonus outrage, AIG also released the list of the top receivers of the payments made from the bailout money. And who were they? Goldman Sachs, Societe General, and all the banks. Bank after bank after bank. Turns out bailing out AIG is just another way to give money to the banks without saying we are giving money to the banks. Number one on the list was GS and ain't it funny how the first fed meeting back in September about what to do with AIG was attended by Paulsen, Giethner, a bunch of other government and Fed officials and one Private bank's CEO. Want to guess which company had a seat at this "governmental" meeting? Yes Goldman Sachs.

This stinks so bad.

It is obvious that Washington is made up of three kinds of people. Blind people, people who don't understand, and evil people. Unfortunately those are the only people who can get elected or appointed because they are the only ones the banks will give money to to run for office. I think Obama is blind. I think Barney Frank doesn't get it. I think Paulsen is/was evil. Ron Paul, who recently introduced a bill to abolish the Federal Reserve Bank may be the only one who managed to get elected despite his ability to see, understand, and care. Remember Ron Paul? The presidential cantidate who looked and sounded like a nut? The guy nobody gave a shot in the GOP race? He is getting more and more floor time lately in congress and it is no wonder. He is turning out to be right.

I can see a silver lining though. For all those who worry about the next generation having to pay for all this, I say no need to worry about that. The USA will have defaulted by then. And default means you don't have to pay back your debts because they have been written off. So as long and Ben and Tim and Barry try to avoid writing off all those bad loans by moving them to the taxpayer's balance sheet, that is how long it will be before the economic recovery will begin. And the more debt they try to pile on in avoidance of that, is how much longer it will take to recover. Welcome to the new Great Depression.

Saturday, February 28, 2009

The real reason we're in such trouble

Everyone mostly blames the downfall of real estate for the economic crisis we face these days. And while that surely has contributed to the problems banks face today, it would not be nearly as bad if the derivatives market had been regulated at all. But it wasn't. And AIG was/is at the center of the whole mess.

AIG is about to post an even bigger loss than before and come to the troth for government funds again. And there is little reason to think the government will not help out still more. Why? Because the government knows that letting AIG fail is basicly spreading banruptcy to probably every major bank in the world, let alone other countries as well.

I am re-printing this article by Joe Nocera of the New York Times because posting a link may require you to join . I feel this is a mandatory read for anybody trying to understand the heart of the problems we face.

*************************************************************

Next week, perhaps as early as Monday, the American International Group is going to report the largest quarterly loss in history. Rumors suggest it will be around $60 billion, which will affirm, yet again, A.I.G.’s sorry status as the most crippled of all the nation’s wounded financial institutions. The recent quarterly losses suffered by Merrill Lynch and Citigroup — “only” $15.4 billion and $8.3 billion, respectively — pale by comparison.

At the same time A.I.G. reveals its loss, the federal government is also likely to announce — yet again! — a new plan to save A.I.G., the third since September. So far the government has thrown $150 billion at the company, in loans, investments and equity injections, to keep it afloat. It has softened the terms it set for the original $85 billion loan it made back in September. To ease the pressure even more, the Federal Reserve actually runs a facility that buys toxic assets that A.I.G. had insured. A.I.G. effectively has been nationalized, with the government owning a hair under 80 percent of the stock. Not that it’s worth very much; A.I.G. shares closed Friday at 42 cents.

Donn Vickrey, who runs the independent research firm Gradient Analytics, predicts that A.I.G. is going to cost taxpayers at least $100 billion more before it finally stabilizes, by which time the company will almost surely have been broken into pieces, with the government owning large chunks of it. A quarter of a trillion dollars, if it comes to that, is an astounding amount of money to hand over to one company to prevent it from going bust. Yet the government feels it has no choice: because of A.I.G.’s dubious business practices during the housing bubble it pretty much has the world’s financial system by the throat.

If we let A.I.G. fail, said Seamus P. McMahon, a banking expert at Booz & Company, other institutions, including pension funds and American and European banks “will face their own capital and liquidity crisis, and we could have a domino effect.” A bailout of A.I.G. is really a bailout of its trading partners — which essentially constitutes the entire Western banking system.

I don’t doubt this bit of conventional wisdom; after the calamity that followed the fall of Lehman Brothers, which was far less enmeshed in the global financial system than A.I.G., who would dare allow the world’s biggest insurer to fail? Who would want to take that risk? But that doesn’t mean we should feel resigned about what is happening at A.I.G. In fact, we should be furious. More than even Citi or Merrill, A.I.G. is ground zero for the practices that led the financial system to ruin.

“They were the worst of them all,” said Frank Partnoy, a law professor at the University of San Diego and a derivatives expert. Mr. Vickrey of Gradient Analytics said, “It was extreme hubris, fueled by greed.” Other firms used many of the same shady techniques as A.I.G., but none did them on such a broad scale and with such utter recklessness. And yet — and this is the part that should make your blood boil — the company is being kept alive precisely because it behaved so badly.


When you start asking around about how A.I.G. made money during the housing bubble, you hear the same two phrases again and again: “regulatory arbitrage” and “ratings arbitrage.” The word “arbitrage” usually means taking advantage of a price differential between two securities — a bond and stock of the same company, for instance — that are related in some way. When the word is used to describe A.I.G.’s actions, however, it means something entirely different. It means taking advantage of a loophole in the rules. A less polite but perhaps more accurate term would be “scam.”

As a huge multinational insurance company, with a storied history and a reputation for being extremely well run, A.I.G. had one of the most precious prizes in all of business: an AAA rating, held by no more than a dozen or so companies in the United States. That meant ratings agencies believed its chance of defaulting was just about zero. It also meant it could borrow more cheaply than other companies with lower ratings.

To be sure, most of A.I.G. operated the way it always had, like a normal, regulated insurance company. (Its insurance divisions remain profitable today.) But one division, its “financial practices” unit in London, was filled with go-go financial wizards who devised new and clever ways of taking advantage of Wall Street’s insatiable appetite for mortgage-backed securities. Unlike many of the Wall Street investment banks, A.I.G. didn’t specialize in pooling subprime mortgages into securities. Instead, it sold credit-default swaps.

These exotic instruments acted as a form of insurance for the securities. In effect, A.I.G. was saying if, by some remote chance (ha!) those mortgage-backed securities suffered losses, the company would be on the hook for the losses. And because A.I.G. had that AAA rating, when it sprinkled its holy water over those mortgage-backed securities, suddenly they had AAA ratings too. That was the ratings arbitrage. “It was a way to exploit the triple A rating,” said Robert J. Arvanitis, a former A.I.G. executive who has since become a leading A.I.G. critic.

Why would Wall Street and the banks go for this? Because it shifted the risk of default from themselves to A.I.G., and the AAA rating made the securities much easier to market. What was in it for A.I.G.? Lucrative fees, naturally. But it also saw the fees as risk-free money; surely it would never have to actually pay up. Like everyone else on Wall Street, A.I.G. operated on the belief that the underlying assets — housing — could only go up in price.

That foolhardy belief, in turn, led A.I.G. to commit several other stupid mistakes. When a company insures against, say, floods or earthquakes, it has to put money in reserve in case a flood happens. That’s why, as a rule, insurance companies are usually overcapitalized, with low debt ratios. But because credit-default swaps were not regulated, and were not even categorized as a traditional insurance product, A.I.G. didn’t have to put anything aside for losses. And it didn’t. Its leverage was more akin to an investment bank than an insurance company. So when housing prices started falling, and losses started piling up, it had no way to pay them off. Not understanding the real risk, the company grievously mispriced it.

Second, in many of its derivative contracts, A.I.G. included a provision that has since come back to haunt it. It agreed to something called “collateral triggers,” meaning that if certain events took place, like a ratings downgrade for either A.I.G. or the securities it was insuring, it would have to put up collateral against those securities. Again, the reasons it agreed to the collateral triggers was pure greed: it could get higher fees by including them. And again, it assumed that the triggers would never actually kick in and the provisions were therefore meaningless. Those collateral triggers have since cost A.I.G. many, many billions of dollars. Or, rather, they’ve cost American taxpayers billions.

The regulatory arbitrage was even seamier. A huge part of the company’s credit-default swap business was devised, quite simply, to allow banks to make their balance sheets look safer than they really were. Under a misguided set of international rules that took hold toward the end of the 1990s, banks were allowed use their own internal risk measurements to set their capital requirements. The less risky the assets, obviously, the lower the regulatory capital requirement.

How did banks get their risk measures low? It certainly wasn’t by owning less risky assets. Instead, they simply bought A.I.G.’s credit-default swaps. The swaps meant that the risk of loss was transferred to A.I.G., and the collateral triggers made the bank portfolios look absolutely risk-free. Which meant minimal capital requirements, which the banks all wanted so they could increase their leverage and buy yet more “risk-free” assets. This practice became especially rampant in Europe. That lack of capital is one of the reasons the European banks have been in such trouble since the crisis began.


At its peak, the A.I.G. credit-default business had a “notional value” of $450 billion, and as recently as September, it was still over $300 billion. (Notional value is the amount A.I.G. would owe if every one of its bets went to zero.) And unlike most Wall Street firms, it didn’t hedge its credit-default swaps; it bore the risk, which is what insurance companies do.

It’s not as if this was some Enron-esque secret, either. Everybody knew the capital requirements were being gamed, including the regulators. Indeed, A.I.G. openly labeled that part of the business as “regulatory capital.” That is how they, and their customers, thought of it.
There’s more, believe it or not. A.I.G. sold something called 2a-7 puts, which allowed money market funds to invest in risky bonds even though they are supposed to be holding only the safest commercial paper. How could they do this? A.I.G. agreed to buy back the bonds if they went bad. (Incredibly, the Securities and Exchange Commission went along with this.) A.I.G. had a securities lending program, in which it would lend securities to investors, like short-sellers, in return for cash collateral. What did it do with the money it received? Incredibly, it bought mortgage-backed securities. When the firms wanted their collateral back, it had sunk in value, thanks to A.I.G.’s foolish investment strategy. The practice has cost A.I.G. — oops, I mean American taxpayers — billions.

Here’s what is most infuriating: Here we are now, fully aware of how these scams worked. Yet for all practical purposes, the government has to keep them going. Indeed, that may be the single most important reason it can’t let A.I.G. fail. If the company defaulted, hundreds of billions of dollars’ worth of credit-default swaps would “blow up,” and all those European banks whose toxic assets are supposedly insured by A.I.G. would suddenly be sitting on immense losses. Their already shaky capital structures would be destroyed. A.I.G. helped create the illusion of regulatory capital with its swaps, and now the government has to actually back up those contracts with taxpayer money to keep the banks from collapsing. It would be funny if it weren’t so awful.

I asked Mr. Arvanitis, the former A.I.G. executive, if the company viewed what it had done during the bubble as a form of gaming the system. “Oh no,” he said, “they never thought of it as abuse. They thought of themselves as satisfying their customers.”
That’s either a remarkable example of the power of rationalization, or they were lying to themselves, figuring that when the house of cards finally fell, somebody else would have to clean it up.

That would be us, the taxpayers.

Monday, February 23, 2009

The "Fight Club" Solution

One of my favorite bloggers is Rolfe Winkler over at Option Armageddon. He hits the nail on the head time and time again and I appreciate it. Among the many financial blogs I read when I can, his is the one that is the most educational and honest and forthright. This past weekend he mentioned the "Fight Club" Solution. One of my favorite movies, in which two guys plan to blow upthe buildings of all the credit card companies. Actually that is just a side plot, but it is amazingly funny how it relates to the situation we are in today. As Rolfe points out:

Few appear to recognize the depth of the crisis we face. Most still aren’t
prepared to ask the hard, fundamental questions about our economic system.
Anyone who mentions the gold standard, for instance, is treated as a
novelty. Nevermind that fractional reserve banking—or perhaps our central
bankers’ management of it—is the most important contributing factor to the
crisis.

The problem, I think, is that so many of our leaders are tied immovably
to legacy ways of doing business. A man will make himself believe most
anything if his salary depends on it. Lots of salaries are at risk, so
lots of heels are digging themselves in.

Anyway, as I’ve argued for awhile, the only way to “solve” the crisis is to let asset prices fall. And that means the balance sheets on which those assets currently reside need to recognize substantial losses. Call it the “Fight Club” solution*—everyonegoes back to $0. This would be highly painful for ALL Americans. But it would be most painful for those with the most to lose…


The good news is that this will eventually happen. In a way it already has started. Our major world banks are insolvent and it is only a matter of time before our governments are forced to recognize this fact and close them down in their present form. How do I know this and the government doesn't? Good question. I listen to what the markets tell me, and when Citi is under $2 and Bank of America is under $3, that tells me the market is only waiting for certain events to happen (nationalization among them) before dowgrading to zero. But nationalizing the banks, which even some Republicans are beginning to endorse, will not fix the problem. Because then the government would become the bank that won't write down these assets. Which will put the government in trouble instad of the banks. Not good. (Unless you are short the US dollar).

Restoring confidence in the financial system can only be acheived when the financial companies themselves become honest about their activites. Which means admitting their assets can't cover their equity/liabilities. Why why why won't/can't the government and the banks see what we americans can easily see? I used to ask this question every day, but I found my answer even though I secretly (from myself) already knew it: "it would be most painful for those with the most to lose."

The banks and the politicians are the ones with the most to lose.


Friday, February 20, 2009

Weekend of Doom?

The Dow gapped down 200 points on heavy volume this morning and is weakening every minute. Citibank is under $2. The banks are taking a pounding. Is this the reckoning? Are we looking at S&P 500 at 500 by Monday? Is Nationalization upon us? This just feels big.

Funny how all americans seem to know the banks are insolvent, but the markets still value them at even $1. Betcha that won't be the case anymore come Monday...I wonder how many banks will be gone...Citi, BofA, both under $4. That's two Dow components for goodness sake. Wells Fargo under $10. Who am I missing here?

Tuesday, February 17, 2009

Can't get Worse, you say?

YIKES! This from Marketwatch:

"A sixth quarter of negative growth (in the S&P) ties the prior record
set when Harry Truman was president, running from the first quarter of 1951 to
the second quarter of 1952.
“‘Next quarter, we’re expecting a new record of seven quarters of negative growth,’ said an analyst.
“As of the close of business Thursday, [he] calculates S&P earnings per share, on a reported basis, at a loss of $10.44 for the quarter. If financials were taken out of the equation, that deficit would drop to $2.35 a share."


So we are about to witness the first ever amalgamated LOSS for the S&P, according to estimates. Of course 80% of the red ink comes from the Financials. Have I mentioned I am short S&P Financials by way of owning SKF (ProShares Ultra Short S&P Financials)?

And I still see pundits on NBC and Fox (yes I watch both) talk about finding the bottom! The bottom of what? The toilet? I had told friends to look for the S&P to test 600 in this quarter (which hasn't come true yet). But a smarter trader I know has reset his target to 450 based on technical analysis of many charts, and I'd have to say that the Fundamentals now seem to agree with him.

Friday, February 13, 2009

Stimulus and Bank Bailout Won't Work

Spend Spend Spend. These days republicans and Democrats may disagree on the nature of the stimulus, Democrats want jobs and social spending and Republicans want tax cuts, but they both agree that something has to be done now. Even waiting to examine the plan for mistakes is too big a mistake in itself. Obama tells us we need stimulus to avoid disaster. Bush told us the same thing last year. This is an emergency. Nevermind that the first stimulus and the first bailout didn't work. We need action! And Fast! It doesn't matter what caused our problems, spending has always worked in past recessions, so spending is the answer to this recession. Hurry!

But what if this is not a recession? A friend of mine recently told me "nobody I've seen has started calling this a depression yet. things haven gotten THAT bad!" Well I fear that depends on who you ask. It has gotten that bad for more people than you think. And its going to get worse, because spending your way out of debt is non-sense and we all know it. Fundamentally, we all know this can't work.


Here's a chart showing the debt to income of the USA. This doesn't include "off the balance sheet" obligations like Social Security and MedicAid. It also doesn't include the stimulus bill that just passed (which will add another 30%) or the final cost of the actual bank bailout. Our GDP has grown at 3-5% per year, yet the growth in debt has been much faster. It is taking increasingly larger units of debt to fuel the same unit of growth in the economy.

And that is the biggest lie of all. GDP. It is not Gross Domestic Product any more. We are not producing anything, we are consuming it. It is really GDC, or Gross Domestic Consumption that our government is trying to grow. And we all know on a very fundamental level, that once you borrow enough, you have to stop spending, if only because you are forced to by your creditors, who stop extending credit.

What is happening to America today, is we are running into a wall, and the government is pushing us head-first into it by moves like the spending bill that just passed. Supposed to be about creating jobs, infrastructure and tax cuts, it instead has items like a $8 billion for high speed rail lines, $200 million in compensation for WW2 injuries, $2 billion in grants and loans for battery companies, money to build schools in towns who are losing population, an AMT rollback costing $70 billion, and much much more that simply doesn't relate to the task at hand, regardless weather or not they are good programs.

Honestly, instead of giving me $13 back per paycheck, Obama and Congress should be asking us for $26 and sinking it into a better healthcare plan for all the people who are losing their jobs.

Thursday, February 12, 2009

The Geithner/Paulsen plan

I have to admit it. I really hoped and even thought maybe Obama would and could change things. But the new plan to save the banks that Geithner presented on Tuesday is basically the same thing as Bush/Paulsen's plan. No details. Give the banks money. And one more thing, "Transparency." But it is basically just a government-backstopped credit call option available to private investors, that exposes taxpayers to even further losses presuming asset market prices are artificially high.

Why won't the government just let the market determine a value on its own? Yes we know it will not be pretty, but as long as government tries to claim that all these mortgage backed securities are worth what people paid for them, this sinkhole will just get bigger and bigger. Printing money only leads to inflation. And at the rate Geithner is accelerating matters (this plan will cost $2 Trillion after Paulsen's failed $700 billion plan), we are looking at some serious hyper-inflation.

The problem is nobody is sure who is solvent and who is not. Can GM survve? Starbucks? Citibank? Your neighbor? When the governmentjust props them all up and won't let any of them fail, then nobody is going to loan anybody any money. Which means no new buildings, no new business to pick up where things are falling. No new jobs to help those in need pay for their rent. And eventually no food on the shelves of the local grocery store. And not enough money to buy what is on the shelf.

I know it is hard to believe that is where we are headed. Take a trip to Best Buy and it all looks the same as two years ago. And inflation? I must be crazy. Have you seen the price of a car lately? Or gasoline? I know I know. Prices are going dOWNN. And for now they are. But believe me, our government's policies are taking us down a dangerous road. Much more dangerous than the also painful road of raising taxes, raising interest rates, and letting banks fail or even nationalizing them. No self respecting Republican or Democrat seems to agree with me (except Ron Paul)

Obama says we need bold moves, but is not delivering them.

Here is Goldman Sachs' research department on the "new" Geithner plan:

KEY POINTS:
1. As expected, the Treasury's financial rescue plan will work within the constraints of existing TARP funding (of which about $350bn remains), attempting to catalyze private sector funds to purchase bad assets and restart the securitization process. However, the speech and accompanying fact sheet leave open many questions about the timing of these interventions and the terms of asset purchases and recapitalization. Much of the program clearly remains to be worked out over the coming weeks and months.
2. Bank stress test. A key feature of the program will be a "stress test" for all banks with assets >$100bn. This will be used to determine which banks need to be recapitalized, or shut down. However, details on the exact nature of the stress test are scant. The Treasury will make additional TARP funds available to purchase convertible preferred shares that will be converted to common "if needed to preserve lending in a worse-than-expected economic environment."
3. Public/private bad bank. Rather than a fully government-funded bad bank, the Treasury will attempt to catalyze private sector investment via a "public-private partnership." This will start at “up to” $500 bn in size, and potentially expand to $1 trn. It is clear from Geithner's remarks that this is a concept at this point, rather than a fully designed entity -- Geithner mentioned getting public comment on the potential structure. Supposedly, private sector investors will determine the prices (perhaps with the benefit of cheap financing or partial loss protection from the government).
4. TALF expansion. As leaked repeatedly prior to the speech, the Fed's Term Asset-Backed Securities Lending Facility will be scaled up by a factor of five to $1 trillion and expand to backing CMBS and possibly RMBS. The goal here is to restart securitizations and thereby expand the flow of new lending (this is not an approach to deal with bad assets). While potentially an innovative approach to restarting securitization, it remains to be seen how effective this program will be. The Treasury's commitment to this would be $100bn rather than the $20bn currently earmarked and would be drawn from the $350bn remaining in TARP.
5. Transparency and accountability provisions. Not many surprises here, though it bears emphasis that the provisions apply to new extensions of aid rather than to those already supplied. Institutions that accept new help will be required to pay only $0.01 per quarter in dividends, refrain from purchasing shares and from pursuing new acquisitions. Geithner also outlines a number of additional reporting requirements intended to keep the pressure on institutions to make new loans.

Monday, February 9, 2009

The Crux of the Matter

Reading about the possible solutions Tim Geithner is going to announce on Tuesday just drives me crazy. Why can't these educated economists see the truth like foolish little me? They are making the exact same choices that our leaders made in 1928-1936 which fueled our last Great Depression for more than twelve years.

Here is the rub. Take for example that 1200 sq ft Miami condo that sold for $1 million in 2005. Its owner could not pay the accelerated monthly payment that his/her ARM charged, and he could not sell it for even $500k. So now he/she has defaulted and walked away, leaving the bank with an "asset" which is worth $1 million on its books, but is really not worth half that. It may not even be worth 1/10th its original price. So if the bank has to write down that asset to 10 cents on the dollar, it would have to take a massive loss for which it doesn't have the equity to cover, thus ending in bankrupcy.

Of course in the case of BofA, Citi, Chase, Wells Fargo and others, we are not talking just $1 million, but hundreds of billions in write downs. Easily more money than they booked in "profits" the past 10 or so years combined! And leverage is the culprit. Not only are our banks leveraged to the abyss but so is our Federal Government.

So Geithner/Obama have been looking at ideas to keep the bad assets off the books of the banks and give them a free ride for taking failed risks. Thinking this will save the economy. We've already tried TARP, which originally was Paulsen's plan to flat out purchase the toxic assets with taxpayers money. Were they going to pay $1 million for that Miami condo? or $800k? or $600k? It doesn't matter because what they did is just hand them some of the money and purchase preferred shares in the banks (overpaying in the process) which did not help the value of those assets go up at all. So TARP 2 doesn't look like it will work to Geithner, so they have floated arount the idea of a bad bank, or using Taxpayer money again to buy up the assets (again at what price?) and put them in a bank created to hold these assets until the value returns. The only fair price for that condo in Miami is $100k, but that would force the banks to book that income at a 90% loss. Something their balance sheet can't handle. That would cause instant bankrupcy.

Then the idea was to "insure" the value of the assets. The banks would pay the government an insurance premium against the value of those assets falling further in value. But that would mean the USA would have to hand over a million dollars for that Miami condo when it finally does sell for $100k.

You see Geithner has to make up something so complicated as to fool the American people and congressmen into believing they are not on the hook for the whole risk taken on the asset to begin with. The crux of the matter is there is only one answer and those in power, weather you argue it is the politicians or Wall Street, are trying everything they can to avoid that answer. What is the answer? Tell the truth! Admit that the Miami condo is worth only $100k. Admit the assets on your balance sheet are worth a fraction of what you say they are worth! Go Bankrupt and wipe out sharehoder value completely and force your creditors to accept the loss of their risk too. Start over from scratch! It is the only answer.

Anything else only makes things much much much much worse.

So the question of the day is what price to pay? Almost any price over 10 cents on the dollar may be too much for that condo in Miami, yet that is what Geithner and Obama are going try to force taxpayers to do. Pay more than they are worth and take the bath for the bankers. Don't they realize that is a recipe for riots?

The numbers I am talking about are real, not because 90% of loans are bad. No it is true that most mortgages and car loans and such out there are pretty good. But when you consider that the most of the big banks' assets are in the form of mortgage backed securities, credit default swaps, and collateralized debt obligations, and that these instruments actually ratchet up the leverage tenfold because they are not regulated, these derivatives will be considered the thing that brought our economy (and way of life it will turn out) to its knees.

Thursday, February 5, 2009

Real Estate Bubble

As I contemplate the economic turmoil we are all only just beginning to experience, I always try to wrap my brain around how it happened. I want to figure it out. How could it get so bad that the pundits now talk about avoiding a depression (which means we are already in one)? I've written some about the mortgage business and about debt and money creation, so now I want to turn to the Real Estate bubble that so many news stories refer to.

I recall , over the years, driving through many towns or cities, including the one I live in, and marveling not just at how many new houses could continually get thrown up (pun intended), but also at how expensive they seemed. On a trip to Washington DC I saw 900 square foot townhomes for $400,000! Even 2500 square foot homes in Dallas asking for the same price seemed steep. I read about $1 million condos (900 sq ft again) in Miami. 40 year old homes in LA that cost $600,000. Of course all they sold. And sold. And sold. How could so may people afford all these expensive homes, I kept asking myself. Then I had to buy my own home and I found out how. I was offered loans that allowed me to pay only $400 per month (with fine print stating that could and would change of course). I opted for a more traditional fixed rate, but at least I knew how all these people could keep buying all these expensive houses. I also figured it wouldn't last forever.

And I also know why there are so many foreclosures today too. Those Option ARMs and alt-A loans are kicking in to higher payments and worse, at a time when many people are losing their jobs. So how did all this happen. Is it just chance you may ask (like I did)?

Here is how it happened.

All the demand for homes (and cars and TV's and stuff too) was created out of thin air by the banks and government who encouraged lending to a larger and larger spectrum of people, using tools like the ARMs and Alt-As and even credit cards to get the demand cranking. With everybody in on the action and buying and flipping homes left and right, demand kept sending prices and values up. And it seemed perpetual. Hairdressers became real estate speculators. Profits were made flipping houses. Additional loans were taken out on the increased equity and spent on other things like cars and TV's and additions to the house. Which paid salaries to people who took out still more loans on homes and it was just a big neverending party!

Of course, every party has to end. And clean up is never fun. But what if every time the party seemed to end we just bought more beer and turned the music up? What if every time we seemed to go into recession, the government just stepped in with more tax breaks and "stimulus" spending and borrowed to do it? Well the party would seem to go on because everybody loves beer and music and free money from the government, don't they? So everyone would continue to hang around and buy more TV's and houses and listen tothe music and drink more beer. Would the party ever end?

Of course it would. You can avoid a hangover can you? And you can't avoid a recession either. Just like a hangover, if you treat it with more beer and loud music it only gets worse and worse and worse. Until CRASH!

Tuesday, February 3, 2009

How money works today

Our economy is based on fractional reserve banking. Long before fractional reserve banking, savers, looking for a safe place to keep their money, deposited it with a goldsmith or other businessman and would receive a note for the deposit. Eventually these notes became a medium of exchange or as money (i.e. they were used to purchase items instead of using the actual gold on deposit). Also, these notes were never redeemed all at once, so the businessmen started to loan the deposits out to other people, collecting interest as profit. Further, they would loan the deposit out many times over. If one in ten loans defaulted, they could cover that loss with the interest collected from the other nine loans given out. All the while, they still only had one deposit to cover the ten loans given out. Eventually these businessmen became known as bankers. And fractional reserve banking was born.



This is one way money is actually created in our society. Your $100,000 deposited at the bank is lent out to multitudes of people. All those people suddenly have (and spend) money that didn't exist before your deposit. And the businesses that receive this lent out money in exchange for goods and services, book it as actual money. The number of $100,000 loans the bank hands out based on your deposit is called leverage. And today many of our banks are "officially" (on the balance sheet) leveraged 30 to 50 time over. Unofficially, or off the balance sheet, they are leveraged 100+ times over. At lease Chase, BofA and Citi are.



Now all of this has worked wonderfully for so long because of the math. If I am a bank and I loan out $2 million based on your $100,000 deposit (20 to 1 leverage) in ten year terms at 7% annual compounded interest, I will make $1.4 million in profit. If three of my 20 loans default, that will only cost me $300,000. Add to that the original deposit and I still profit by $1 million. In fact I could cover the default of 13 of the 20 loans without suffering the loss of the original deposit. And even if I did have 13 defaults, I would still own the property purchased with that loaned out money. Which (as long as there are buyers of land) will still net me a profit. Really wonderful since historically, even the riskiest loans (made to people with a questionable credit history) have not defaulted at even close to a 65% rate. Of course the riskier the loan, the more you charge in interest to mitigate the amount of profit with the expected loan default rate.



Naturally it costs more than nothing to run my bank over ten years, so to cover the salaried employees, the building costs, etc. I would need to have a lower default rate, charge more interest, increase my leverage, or some combination of the three. And if I pay myself handomely today with all that profit I expect to earn tomorrow, but that profit doesn't materialize, I could be in trouble and may have to ask the government for assistance.



Now this is a simplified explanation of how it all works, but I don't think the complicated explanation is even necessary to help understand the trouble we find ourselves in today.



Our banks today book those loans as assets and value them at the amount loaned out plus the interest they will collect. (of course they "write down" the value as the defaults increast, too)Then they resell those loans to other banks and brokerages who then package them into collateralized debt obligations (CDO's) and in turn re-sell them to retirement funds, pension funds, 401k funds, municipalities, state treasuries, and anybody who is willing to buy them. And of course these "investments" are rated by credit rating agencies so the investor can know how safe or risky the investment is compared to other investments. So essentially everybody is loaning money from their savings (weather deposited at a bank or invested in a debt fund) to everybody to buy homes and cars and TV's. And as long as there are buyers for all this stuff, everyone is happy because the value of the loans is equal to or less than the value of the assets they represent.



Our banks and investment houses today have also been buying (and selling for that matter) "insurance" against massive default of these loans by purchasing credit default swaps (CDS's) from other companies. They will pay a fee to a company, who will in turn pay down the debt obligation if the default rate exceeds a certain threshold. But these companies who sell the swaps (including both insurance companies like AIG and investment banks like Bear Stearns) don't want them to be called insurance because insurance is a regulated (by the government) industry. Being regulated would mean they would have to hold x dollars in reserve to pay out claims. Which would mean less mean less money available for houses boats and TV's. So these tools were called "swaps" to get around this issue. And our government has been inclined to de-regulate financial markets the past twenty or more years anyway. So the companies who sold "swaps" were not keeping really any money in reserve in case of massive default rates on these debt obligations.



Which leads us to where we are now. There is alot more to why our economy has no hope of recovery. And much of it has to do with the steps the government is taking to avert "recession." But that is for another day. More to come.

Friday, January 30, 2009

Did you know?

I'm sure most who may read this may know the basics (which I'm posting anyway just in case). But I'm including interesting facts with them as of December according to the Wall Street Journal.

Sub Prime Loans are mortgages (and car loans) that go to people with poorer credit. Regarded as risky loans they carry higher interest rates. More than half of those $1.9 trillion (including Jumbo) issued from 2004-2007 are delinquent, in forclosure, or owned by the banks as of December. (These loans were made using math assuming less than 20% would default). This what is referred to as the "Sub-Prime meltdown."

Prime loans are mortgages (and car loans) that go to people with good credit. Regarded as less risky loans, they carry lower interest rates. 6% (so far) of prime loans issued from 2004-2007 are delinquent, in forclosure or owned by banks (again as of December).

Option ARM loans are prime loans that carry a multiple payment options including the ability to pay less than the interest for a given month (thus adding to the principle). Approxiamately $750 million of these loans were issued from 2004-2007. Of these, 28% are delinquent, in forclosure, or owned by the banks. Goldman Sachs estimates that 61% of those issued in 2007 will end in default (not that I trust Goldman Sachs to know what they are talking about; I bet it will bemuch more).

Jumbo loans are loans larger than $500k. I couldn't find numbers for Jumbo loans, but I don't think it is unfair to classify them with sub prime (as mentioned above) for purposes of estimating default rates.

There are additional types of loans that fall under Prime or Sub-Prime headings, but the above basicly covers the vast majority by description. When you see those numbers, you must realize that the "voo-doo math" that was used to compute rates of default and thusly interest rates to charge, basicly yielded less than a 20% default rate. So far, only true prime loans have lived up to that number. So far.

So when you think about the trouble that our banking system is in, you must realize that it is at least three times worse than has already been revealed. And that does not include derivatives trading, which I will address in a future post. Or the leverage problems the banks face which I will also address soon. But this is why I will harp time and time again about the need for our banks to come clean and "reveal what is in their vaults." The truth being told is THE ONLY WAY for us to get out of this mess we are in.

And the truth is not being told because if it ever is, all (and I mean ALL) the people who have power (CEO's, Bankers, Congresspeople) will be exposed as liars or stupid. And we know none of them want that.

Thursday, January 29, 2009

Bailout after Bailout after Bailout

This article was of particular interest to me so let's talk about it:
http://www.businessweek.com/magazine/content/09_06/b4118000455725.htm?chan=top+news_top+news+index+-+temp_top+story

I don't suppose Obama/Bush or Paulsen/Geithner would admit they knew ahead of time that their $700B bailout late last year wasn't going to work. But it is hard for me to see how they couldn't. It's only been three months and they are already talking about $4T and a bad bank idea. And that smells fishy to me. As those who know me would attest, I saw this coming. So why couldn't they?

I just love this quote from the article I linked above: "New Treasury Secretary Timothy F. Geithner is exploring the creation of a government-funded "bad bank" to buy up mortgage-backed securities and other troubled assets from banks in hopes of boosting their capital levels so they can begin lending again."

So it's not just enough to get all those bad loans they've made in the past off their books, they have to get them to make still more loans? How stupid can these people actually be? Do they really think that debt spending is going to produce a healthy economy? I suppose they know that 70% of our growth since the 90's has been consumer spending and debt has been the primary driver of all of that spending, so they must think that is the only way to grow the economy. It all has me wondering if growth is what we really want if this is where it gets us.

Meanwhile still more layoffs were announced today by Fedex, Cessna, and others. Every day the announcements are coming now. And each month the numbers grow larger. ABC news reported today that 4.5 million people are collecting unemployment. The highest number ever.

The other big news was Obama's televised disgust at the $18B in bonuses paid out to Wall Street companies who received hundreds of billions in bailout finds last year. Sure, it's 40% less than last year, they say, but it is still the sixth highest payout ever! I'm sure you feel the same disgust Obama and I do at this news. But there is a much bigger problem brewing that nobody is talking about yet. You mix more and more bailout money for Wall street with Unemployment at record levels with big bonuses for the fat cats and you've got yourself a recipe for social strife (also known as riots in the streets). In many counties this means a coup d'etat.

Remember Congress and President Bush did the opposite of what the American people wanted last October when they passed the $700B bank bailout. And it didn't work. And now, as soon as this economic stimulus becomes law, you just watch them come back to the troth for more Wall Street funds. Heck they're already writing about it at BusinessWeek.

It's a real bank,but is it Solvent?

I may switch to this bank just cause it's funner.

A Funny

Tip of my cap to Emil, a good friend who turned me on to this. It is funny enough to post and rings true enough not to laugh much. Remember this is only a joke. Well, mostly anyway.



*****************************************************************************

This year, taxpayers will receive an Economic Stimulus Payment.This is a very exciting new program that I will explain using the Q and A format:


Q. What is an Economic Stimulus Payment?
A. It is money that the federal government will send to taxpayers.

Q. Where will the government get this money?
A. From the taxpayers.


Q. So the government is giving me back my own money?
A. No, they are borrowing it from China. Your children are expected to repay the Chinese.


Q. What is the purpose of this payment?
A. The plan is that you will use the money to purchase a high-definition TV set, thus stimulating the economy.

Q. But isn't that stimulating the economy of China?
A. Shut up."

Below is some helpful advice on how to best help the US economy by spending your stimulus check wisely:

If you spend that money at Wal-Mart, much of the money will go to China.

If you spend it on gasoline it will go to Hugo Chavez, the Arabs and Al Quada

If you purchase a computer it will go to Taiwan .

If you purchase fruit and vegetables it will go to Mexico, Honduras, and Guatemala (unless you buy organic).

If you buy a car it will go to Japan and Korea .

If you purchase prescription drugs it will go to India

If you purchase heroin it will go to the Taliban in Afghanistan

If you give it to a charitable cause, it will go to Nigeria.

Yet none of it will help the American economy. We need to keep that money here in America .

You can keep the money in America by spending it at yard sales, going to a baseball game, or spend it on prostitutes, beer (domestic ONLY), or tattoos, since, those are the only businesses still in the US.

Wednesday, January 28, 2009

I heart Peter Schiff

I'll start with one of my favorite Youtube events:
http://www.youtube.com/watch?v=2I0QN-FYkpw


This is Peter Schiff, a (now) respected economist, talking about our present economic situation as early as 2006. He successfully predicted the financial boondoggle we find ourselves in today. This one is really funny because the folks on the other side of the desk literally laugh at his face. Ben Stein, Steve Forbes, among others tell him he's lost his mind and go on to recommend their favorite stocks to you.

It just goes to show you that people don''t like to hear the truth when it doesn't suit them. It has been pretty obvious that consumer spending has made up the vast majority of our GDP growth for many many years running now. But even today you can turn on CNBC, Fox Business, ABC, NBC (Lord help you), CBS, or Bloomberg and hear them talk about having reached a bottom, and/or being in a "recession" for another quarter or two before the turnaround.


And they talk about the "stimulus" package that is about to be crammed down our throats as if it is something that "has to be done." Even the most expert of experts says things like "action must be taken," or "any action by the government will help stave off disaster" or worse "our government can't do nothing." As if they really know what they are talking about. And get this: None of them do! Seriously. I know you're going to think they must be smarter than you or me to be where they are. Call me stupid if you must, but Robert Rubin and Larry Summers and Timothy Geithner and Warren Buffet are numskulls if they think that the Government can borrow their way back to 5% GDP growth. And that is exactly what they think. Even you and I know that if you are in debt up to your eyballs, the answer is not to incur still more debt. And poor Obama, whom I think is a good man, is listening to them.

The banks are sitting on credit card debts and commercial loans and home mortgages in which 25% or more of them will not get paid back. But they are valuing them as if they will make 10% interest (compounded) on it! They are so far in the red that they are effectively insovent, the FDIC doesn't have 1% of the money to cover the deposits, and our government wants them to loan us even more money to get the growth going again. This is absolutely insane. And the end result is going to be $20 per gallon of milk in about two years. I will get to the details of why this is true in future posts, but believe me it is coming and it is not hard to understand why.

It all started with a debt as money economy combined with no regard for leverage in the bank vaults. What I mean is our banks have taken your $1,000 and loaned it out 40, 50, even 100 times over. And paid themselves handsome bonuses for doing it. And many if not most of those loans will not be paid back. Our banks are screwed. Which means our businesses (notice I don't classify a bank as a business) are screwed, which means we are screwed.


Oh well at least we are all screwed together right?