Missed It By One

I personally guessed three bank failures this week but it turns out to be four. It will get worse so get used to it.

http://www.calculatedriskblog.com/

It Is NOT a Recession, It Is REALITY - Get Used To It!

The article I am linking here compares our present economic demise to what happened in Japan in the 1990s. Japan suffered 15 years of real estate declines and over a decade of stock losses. It just started to recover a few years ago when the current recession hit it as well.

Here to me is one key paragraph in the article which comes early in the read:

"Only in 2003 did the government finally take the actions that helped lead to a recovery: forcing major banks to submit to merciless audits and declare bad debts; spending two trillion yen to effectively nationalize a major bank, wiping out its shareholders; and allowing weaker banks to fail."

I hate beating this nationalization drum so much but at some point someone important may pay attention. The second paragraph of this article to get my attention is that the U.S. seems to be in a similar situation:

"More alarming? Some students of the Japanese debacle say they see a similar train wreck heading for the United States."

And as big as you think the current plan is in the U.S., those who studied Japan think it is "timid." We cannot, however, afford anything else.

And here are a couple of key paragraphs. Japan tried what we are trying and it worked so (not) well. Oh well, go figure?

"Instead, the Japanese first tried many of the same remedies that the Bush administration tried and the Obama administration is trying — ultra-low interest rates, fiscal stimulus and ineffective cash infusions, among other things. The Japanese even tried to tap private capital to buy some of the bad assets from banks, as Mr. Geithner proposed.
One reason Japan’s leaders were so ineffectual for so long was their fear of stoking public outrage. With each act of the bailout, anger grew, making politicians more reluctant to force real reform, which only delayed the day of reckoning and increased the ultimate price tag. Japanese taxpayers are estimated to have recouped less than half what it cost the government to bail out the banks."

Overall, what Japan tried and we are trying is too comparable for comfort.

http://www.nytimes.com/2009/02/13/business/economy/13yen.html?_r=1&ref=business

Here folks I will say again what I have been saying for a long time; we are in a very serious correction. I say correction as I truly believe we are righting ourselves. I say correction also because, as sure as hell, things were not right in 2007, so where we are going is a better place. We, as a people, were spending well beyond our means, and I mean WELL beyond our means. Our major financial institutions developed instruments that generate great wealth - for them - that allowed us to spend beyond our means. This period was doomed to failure and unfortunately got so severe that it is incredibly difficult for us to face.

My take is that we should do as little as reasonably possible and let the economy correct itself. I am not traditionally an extreme free market type of person. In a period of economic growth, especially great growth like we had leading up to 2007-2008, I am highly suspect that the market it operating properly. Moreover, I am a firm believer that capitalism and Karl Marx, in his Communist Manifesto, share the same delusion, which is believing in the ultimate good in human nature; some (many) people, including some in power, irrationally seek short term personal gain over long term rationality. Despite not being the biggest fan of a "free" market economy(because some prudent level of government checks and balances is needed), I am a big fan of the economy correcting itself mostly on its own. We need backstops to help the victims of the correction, but in the end trying to stop it is foolish. Property and other assets will revert, and probably overshoot, the mean (the reality) on their values. We at best can prolong this happening but cannot prevent it, so in my book it is best just to let it happen, put it behind us and get on with it.

The same is true with other businesses. The U.S. consumer for quite a while has been spending well more than they make and can afford. Their homes were their piggy-banks (I am among them) and their consumption seemed nearly limitless. American businesses added new retailers, outlets, malls, etc. to meet this increasing (false) demand. Now the demand is gone, so it is no surprise that so many businesses are closing down.

And here my friends is the most important thing I will ever tell you!!!!Way too many people think the demand has just been reduced for a period of time. They believe this is a recession and things will eventually, if not soon, return to normal and the consumption will resume. Politicians are at the top of this list. What they fail to realize is that the last five to ten years were not normal. They were abnormal. Spending beyond our means is not the historic mean or sustainable. And so we face a new reality. A reality that is - hopefully - here to stay. It is in a way painful, but the sooner we realize it and embrace it the better.

We have house prices returning to reality. We have consumption returning to reality. We have many sectors returning to reality. Some would call it mean, but for this post I am calling it reality. And reality is undoubtedly an economy somewhat poorer and more deprived than we are used to. Less pay, fewer benefits, fewer jobs, fewer services and the like. We face a society with less and fewer on many fronts. What the government really needs to do is pare down and adjust for this and not try to artificially get us back to our foolish ways.

I posted a week or two ago on how families are coping in many respects for the better. Shopping trips, dinners out and movies are being replaced by dinners at home, game nights with neighbors and conservation. Buying is being replaced by barter. Families are moving in together. People are helping other people as best they can. The reality to which this recession/depression is forcing us is in some respects a better reality. This is not to say that my heart does not go out to those without jobs, benefits, food, heat or the like. It is upon those that I think the billions of government support needs to be spent; not the financial clueless that brought us here. I for one hope for a better, simpler, tomorrow. My biggest fear at the moment is that the government will do so many stupid things in trying to stop a correction -stopping an adjustment to reality - that we will be totally screwed for a decade or two. Let's hope not.

Disclosures: None.

Parallel Universe

I just logged on to my brokerage account and the week end wrap up starts with this:


"Valentine's Day lies ahead, but the coming week should feel more like Christmas because the government is on track (we presume) to deliver some new recovery packages for the financial sector and the U.S. economy.
Just as any child has a feel-good vibe for Santa Claus, the market appeared to have a feel-good vibe for the impending packages as evidenced by a 6% gain in the financial sector and a 5.2% gain for the broader market this week.
It was an interesting response given the absence of confirmed specifics on the structure of these recovery packages, which are separate but likely to be at least equal in their high cost."

Okay, am I missing something? I am looking at charts for theS&P 500, Nasdaq Composite Index and Dow and they all seem down roughly 3-5%. After writing the last sentence I returned to my brokerage (E-Trade) and the Weekly Wrap now sounds correct. It now notes financials were down over 10% on the week, and that the various markets were down 3.6% to 5.2%. Maybe the first report was someone's wishful thinking. Pretty weird either way.

Disclosures: None

A Response To A Different Plan

John Lounsbury, who has had many very wise posts at Seeking Alpha, commented today on my Nationalizing Banks thought as follows:

"The following is a duplicate of a comment I made to another SA article. I bring it here in hopes of getting more discussion. Listening to the bank CEO testimony before Congress yesterday, they all seem to believe they have good prospects and need limited additional direct government help. Are they simply holding weak cards and making poker players' bluffs? Let's take these testimonies at face value. What then should be done with the next $350 Billion in TARP money? Let me throw out a wild idea for discussion. Take $200 Billion of the TARP II and provide investment capital to establish 10 new national commercial banks. This is $20 Billion per bank. The management structure for each bank should be recruited from the private sector and each should have its own individual board of directors, with one government representative on each board. These banks would be unencumbered with legacy assets and liabilities. This would give them much more flexibility than the existing banks in how they deal in the credit markets. This would distribute the banking sector risk across a larger group of banks and make future regulation against monopolistic concentration of banking power more tenable. Getting rid of "too big to fail" banking structures would be easier in the future. In the next few years, these new banks would be taken public with IPO's, the proceeds repaying the initial capitalization and providing some combination of capital gains for the taxpayer (at a prespecified maximum government return, say 15% per annum) and additional capital for the banks (above the government's capital gains). Okay readers, what's wrong with this idea (besides being off-the-wall)"

So here is my take on what I think is wrong with John's proposal. On its face I like it but consider this:

• for a while I debated with others whether Fannie Mae and Feddie Mac were responsible for our economic woes. My position was that they for the most part did not participate in the subprime market until very late in the day - as their underwriting guidelines did not allow it - so they were not responsible for the mess;
• I then read an article that made a lot of sense to me. Fannie and Freddie had an implicit government support. This allowed them to borrow at more favorable rates, which allowed them to lend at more favorable rates. Accordingly, for other banks to compete and make money, they needed to do subprime loans Freddie and Fannie would not do. And to maximize their profit, these financial institutions needed to securitize these loans and lend more. The unfair competition of Fannie and Freddie forced them to desperate means, though they were happy to take on subprime loans that they could securitize at stupid ratings. As long as cerdit rating agencies were willing to give this crap high ratings and as long as the banks could pass this crap to others, all was well. I do not blame Fannie and Freddie for the end of this idiotic process, but having an unfair government advantage, in terms of implicit government support, st the seeds for this process to take hold.

• And so, John, I think creating new banks with no debts sounds great - and I think I have supported same before - but at this point I think it carries too much threat to too many banks. Sure, some are insolvent and in my book need to be taken down, but some should, survive, but cannot compete against a government sponsored bank. I think we need to support those on the edge, yet nationalize and sell off the big fish that got us here. Just my take.

By the way, I am starting a raffle. It is based on banks going down each week. I have read expectations that a thousand banks will fold this year. I consider that on the very high side. Nonetheless, this week my bet is on four banks being taken down tomorrow by the FDIC (they virtually always do it on Friday). If none are taken down, I would consider this a honeymoon the FDIC is giving Obama. Place y0ur bets.

Disclosures: None

Housing Woes Continue

Let me just quote the first few words of this Bloomberg article "Home prices dropped the most on record in the fourth quarter . . ." I think I need to add no more, but I will. This year there are a lot of Alt-A loans - the level between prime and subprime basically - that are coming under pressure. These include a number of option ARMs, which are basically adjustable rate mortgages that were designed for a niche market that were marketed much more broadly. The option gave the borrower an option on what they wanted to pay, often including a choice to pay less than even just the interest on the mortgage. And even those that chose options that paid off interest have seen their homes go under water, i.e. worth less than the mortgage. The same is still happening on the subprime front and increasingly becoming a problem on the prime front. So a record decline is no surprise and these records are likely to continue this year and a bit into next year, judging from ARM reset dates.

http://www.bloomberg.com/apps/news?pid=20601087&sid=aY8hiszeIlbU&refer=home

Me Smell Something Bad

Here is a very enjoyable letter from the NY Attorney General about the bonuses at Merrill Lynch and their dealings with BofA. Seems the $4 billion in bonuses paid for by taxpayers is earning some attention. I liked his father as governor when I lived in NY and I like this move by Andrew Cuomo. I hope he nails the bastards (pardon the french) to the wall. These arrogant jerks need to be in jail or bankrupt, either one is fine for me. I hope he does not give up on this endeavor. If only Obama's people would take up this charge. I voted for Obama, and still think he is a better choice than McCain, but I am so far sorely disappointed. I expected more.

http://beacheconomist.com/CuomoMerrillLetter02-10-2009.pdf

Disclosures: None

Banks Are Poor Investments - According to the Banks

So an analyst at "Bank" of America is now telling us that:

• banks are bad investments;
• certain large banks should be closed;
• FDIC insurance should be increased; and
• takeovers should increase.

Now I suspect that his plan is that BofA will be one of the banks taking over their insolvent brotheren, but they have already bitten off more than they can chew and I do not see that happening. In my book, I agree BofA should be closed. They may be too big to fail but they are not too big to resell in pieces. Any hoot, I am wondering if this guy will have his job tomorrow as (as I read it) he just told the painful truth about his employer. I respect his honesty.

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aoc1E2sKjADk

China Again

I have noted in past posts that China is in a true troubled state. The extent of their problems is exceeding difficult to define. The news is very varied and suspect. And judging by those commenting on my posts, some seemingly from China, not even all the information there is consistent. And so I give up this dismal stat - which is from the government - for what it is worth. Whatever it is worth, it is not cheery. When exports fall 17.5% YoY in any economy, that is not good news.

http://www.nakedcapitalism.com/2009/02/chinas-exports-fall-175-most-since.html

There is a lot that I could post but nothing right now too worthy. Yes, it looks like the House and Congress may have a Plan to take to Obama, but if you cannot find a thousand articles on this and why it will not work, you are not trying. I am in the it-will-not-work camp, so I can add that it is time to plan for a depression. Hunker down - big time.

Disclosures: None.

Have I Mentioned Nationalization?

Obama was flat out asked about nationalization of banks. His response is effectively that we are not like Sweden -they had five banks we have thousands. He ignores a couple of key points here. First, like it or not, the FDIC is going to be doing something akin to nationalization on a grand scale this year and next, especially for smaller regional banks. They are already up to nine this year and I suspect the pace will advance. Second, as Calculated Risk points out, there are only a handful of key large institutions that need to be nationalized, so we are not so different from Sweden. And as Calculated Risk points out, the Japan model is the alternative mentioned by Obama and we have good proof - as in Japan - that its model did not work. So we are not doing a plan that worked because we think we are different, but we are doing a plan that is proven wrong. I have more doubt by the day.

http://www.calculatedriskblog.com/2009/02/obama-on-nationalization.html

And Geithner's plan to have a public/private plan to support banks is a bit laughable on the private side. I do not see private capital going to such risky places when there are so many good companies at wonderful valuations at the moment.

Let's think for a moment about the problems with these financial institutions and why it might be better to put them out of their pain:

1. Their traditional means of making money - good money - are mostly gone or totally shot. They are not likely to make significant profit, even without the losses on toxic debt, for years to come.
2. So with little promise of future profit, how long do you think it will take them to pay off their tens, even hundreds, of billion in debt to us taxpayers? Take your time and respond when you feel comfortable. I am guessing it is a longer window than most private investors/speculators are willing to wait.
3. The toxic assets keep going more toxic all the time. And they will do so for some time. We are in a downward spiral and I do not see us getting out of it soon.
4. The management that got the financial institutions into this mess is still in charge. How much faith do you have in their ability to turn things around?

Just a few thoughts to chew on. Doesn't that nationalization thingy sound worth a bit more thought now?

Disclosures: None

What Looks Like, Smells Like and Certainly Feels Like a Depression, Is A ___?

I have danced around the edge of this for a while but not committed myself. Well, I am doing so. As with my predictions at the beginning of the year, I hope I am wrong. I feel now that we are heading into a depression. The only question remaining in my mind is how severe it will be. One common definition of a depression is a decrease in GDP of over 10%. I don't see how we can avoid that. But how bad can it get. In the Great Depression GDP went down 33%. It recovered but then we had another 18% drop in the 1937-1938 time frame. I am currently thinking we will be close to the latter this time around before all is said and done.

I am by no means alone in this thinking. More predictions along these lines are being made daily. I probably read four today and I had little time today to read. Don't take my word for it, listen to Ray Dalio. Don't recognize the name? Maybe it is because he is not a big headliner doom-and-gloomer. He speaks instead with his results and he has produced good returns for his clients in good times and bad. Last year his funds made money - around 9% - and he does even better in good times. So when Dalio talks, it is worth listening and listening very carefully.

http://online.barrons.com/article/SB123396545910358867.html

His interview with Barron's is a must read in my opinion. He spells it out in terms pretty much anyone can understand.

The increased depression talk of late also suggests that the market is poised for another significant leg down soon. Yes I did see the drop today, but that is not the drop I am talking about. Today's market drop was due to Geithner doing poorly. The markets are mostly still trading in the same range they have been for some time. We are close to the bottom of the range after today's drop but still above support levels. I suspect we may soon break through those support levels and set a new, lower, trading range.

I am not saying that the markets will drop due to fear caused by increased depression talk. Rather, I think they will fall more due to reality setting in. And the reality that is setting in is that this is, as Dalio puts it, a D-Process. This economic downturn is different, much different, than what most people have seen in their lifetimes, and that reality is just setting in for many. We are in a depression cycle. Dalio explains it quite well, but it starts with too much debt and too little ability to pay it off, both on a corporate and individual level.

Disclosures: None

Obama Speaks

I am watching Obama's press conference and typing this as he speaks. Here is my take:

1. He definitely gets that our economy sucks wind and we are in dire straights.
2. The fact that he is focusing on spending on alternative energy, health care, infrastructure, education and similar spending that creates jobs sounds good to me. This is versus tax breaks, which he is against, and I agree. Sure I would like a check in the mail. I just know I will need to send a bigger check later to pay it off. While I like what he is saying here, I do not think this will fix the problem, just that spending the money on these causes will be much better than pouring our money down the drain. And through job support it will help to ease the pain while we wait for the economy to finish its correction, which it will do on its own if we let it.
3. He notes that no one aspect of the plan will necessarily work (he has that right) but that we need to act. Since his recommend plan is supporting things that make some sense, I agree. We simply need to control the fallout. Damage control.
4. Now it is question and answer time. First question relates to number 1, i.e. he is calling it like it is. Are you making the problem worse by calling it so bad? Well, he is right, we cannot stick our heads in the sand. He is right we are going through the worst economic crisis since the Great Depression. We need to recognize the problem and that we can get out of this, but getting out of it first requires a recognition where we are. Moreover, Obama needs credibility here and he is saying the right things to gain it.
5. He is right that we need to avoid a downward spiral. There are some needed fixes in terms of valid businesses that need credit and deserve credit getting credit. This does not mean I think the way to do that is to prop up failed financial institutions, hoping they lend again. Unfortunately we have to wait for Geitner to tell us tomorrow how he will get credit flowing again. From what little Obama is saying, this part sounds the worst of what he has said so far. It sounds like we will still rely on the big financial institutions here, with some prodding to do the right thing.
6. A foreign relations question on Iran and nukes. He knows the buzz words but the jury has to be out on what he does here in the long term. Honestly, job one for pretty much all this year (and hopefully only this year) will be our economy, so he will have less time to spend on Iran and nuclear issues. Can't be ignored but second or third fiddle at the moment.
7. A question on whether the plan has bipartisan support, which so far based on the vote it does not. Right now he notes that is politics as usual, but he did the unprecedented move of putting three Republicans in his Cabinet. He does do a good job noting that he cannot focus on politics; he has to focus on helping out American families, though he hopes to work with Republicans. "My bottom line is, are we creating four million jobs." That he says is his top priority. To be clear he said earlier it is to create "or preserve" four million jobs. Nice goal, but how do you judge success?
8. He is lamenting now on our inefficient health care system and he is right. We spend more than any other country and still have health care that is no better than and perhaps worse than a number of advanced countries with much more reasonable costs.
9. A good question on consumer spending getting us into this mess. Obama dodges a bit pointing the blame at financial institutions but admits consumers spent too much on debt and that cannot continue. Yet he still thinks job one is to continue some spending through stimulus to stabilize the economy first. Then the government and individuals can deal with their debt load and prudently reduce it. My take is that he wants to create a new bubble through stimulus to stabilize the economy. We then need to slowly let the air out of that bubble in a way that does not destroy the economy, i.e. pop the bubble. Admirable goal, but in my book not possible. We need to let the current bubble deflate completely, control the fallout, pay down debt at individual levels and then rebuild from the wreckage. It will be painful, but it leads to a productive survival of the fittest on the business front.
10. The four million jobs thing is his key piece and the one I like most. We need a trickle up recovery. So long as the spending gives us some public benefit, which is where he is focusing, then it is a logical way to control the pain. I just do not believe you can get this many jobs out of the categories on which he focuses.
11. Stabilizing housing prices is another goal. This is fool's gold. They will bottom and the bottom will likely overshoot true value to the downside. Trying to stop this is a waste of money. It has happened numerous times before and will again. Helping people who lost their homes find affordable rental housing is key here, and the rental market seems to have a lot of room for more tenants, so the newly homeless just need support to afford it.
12. A question on Iraq. He dodges a bit. Not too surprising as I am sure there are things he was not told until he took the office.
13. Next bank bailout question and what strings we will tie. He is trying to avoid preempting Geitner on the big news. Is credit flowing to those needing it, who can and do provide jobs. Details for Tim to say tomorrow.
14. A question on Joe Biden saying we have a 30% chance of failure if we do everything right. Obama does not recall what they were discussing but admits not everything will work. Not everyone agrees on the answers. They are working various fronts at the same time and hopefully most will work.
15. Alex Rodriguez's admission that he used steroids when with the Texas Rangers. Depressing news and not good for the kids who look up to atheletes. Obvious answer. He goes on to note a better answer that losing your integrity is not worth it.
16. As a side note, he looks like he has glitter on his eyelids. And he is blinking a lot, which is a sign he is either nervous or not telling the truth. I say the former. Can you imagine the pressure this guy is under right now. You could not pay me enough.
17. Very few economists suggesting we do not need a "recovery" or "stimulus" package. My comment, of course I am not one (economist), but think about how many economists saw this mess coming.

Just my write-up on his first big televised event as President.

Disclosures: None.