The Eye of the Hurricane

Today Geithner came out and announced that the vast majority of banks have adequate capital to be considered well capitalized. OMG - pick me up off the floor. What a shocker that the government would tell us that banks are well capitalized. I am having flashbacks to Paulson and others telling us in 2008 how fine and dandy everything is and the American economy is strong.

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=asTVO5RFuZ.Y

Well let me add a few considerations to the equation. First, for the major banks - you know the 19 getting fake stress tests - they definitely have adequate capital because we have given it to them with very few strings attached. So let me count the ways that the top 19 can - AND ARE ALLOWED IF NOT ENCOURAGED TO - to cook their books:

• first the FASB has changed mark-to-market accounting rules further enhancing the ability of banks to mark-to-fantasy. Transparency is out the window;
• I have read that AIG has been actively paying on and closing out CDS positions in the first quarter for 100 cents on the dollar with our money. I am not sure this is true but the TARP oversight folks have this in their sights for an investigation. If correct, the profit for these companies came straight out of our pockets;
• Banks are getting money for free or close to it so making money is nearly like printing money. This will not continue forever; and
• Most have some one time items on their books not likely to be repeated.

There is more here, but this is a good start.

Let's talk about the Stress Tests for a moment as the results are supposed to be made public in early May. As Nouriel Roubini points out, the base line for the tests is way off and even the worst case assumptions in many areas are already optimistic. It is a non-stress test, if you will. And of course they all will pass.

My bigger concern is turning to regional and local banks that for the most part are not at fault for our current problems. They are a good size. They are not too big to fail or too big to save. Just right. Yet many are going to go under because their competition in some markets - big banks - are getting billions in taxpayer funds to create unfair competition. Let me repeat - good banks will go under because we are supporting the banks that got us into this mess!!! This really really is getting me at the end of my rope. I am infuriated that we are doing this, creating massive moral hazard, supporting the idiots that created this situation and excusing it as a necessary evil. The necessary evil is the US Government. Beyond that these idiots need to be taken down and sold apart in pieces. Don't take my word for it, numerous very very prominent economists agree:

http://news.medill.northwestern.edu/washington/news.aspx?id=126671

So what is the health of the banking industry? Some of the big boys reported profit this past quarter based in part on refinancing. Yes, in some markets refinancing loans are the majority of new mortgage loans being completed. I am myself in the process of refinancing. With rates under 5% why not, if you can. So these banks are refinancing left and right for under 5% and they are generating some fees off of these. Hmmm.

This in my opinion is the eye of the hurricane. Banks are making false money on many fronts. They are in a calm eye of the storm. In time, we will return to more turbulent times.

What happens when the government pours literally trillions of dollars at fixing our economic ills? You got it - massive inflation. We are deflationary at the moment but in time, perhaps a year or two from now, this will all change. The inflation bubble will begin.

Let me put this to you in other terms. Let's consider what will happen in the next few years. I propose there are three basic scenarios as follows:

1. The economy - like Japan's lost decade - continues to crash and the banks that are refinancing face a new wave of foreclosures. Not good.
2. The economy stays flat. Let's say it is an "L" shaped recovery. The refinancing profits are a one time thing and the profit from doing them is over. Not good.
3. The economy takes off due to the stimulus, but the stimulus is so extreme that the inflation rate goes up to 5 - 10 -12%. How much money does a bank make on a 4.7% fixed rate loan if inflation goes to 10%? Not good (unless you are the homeowner with the 4.7% rate)

What I am saying is that the banks are not in the clear yet. And we are not there yet either. We are in the eye of this storm in my opinion. Hunker down!

Disclosures: None.