Nice Transperancy

The Financial Accounting Standards Board ("FASB") has altered the rules in the U.S. on mark-to-market, thus easing the pressure on financial institutions and, thereby, alleviating some of their capital to debt ratio strain. After all, with the old standards mark-to-fantasy was undoubtedly getting harder to pass by the auditors. Now they have a new lease on life and mark-to-fantasy is officially blessed by the powers that be. Go figure.

Obviously the U.S. is well out in front of all other countries in liberating the jerks that got us here from any sort of rationality, so the EU now feels compelled to do the same for their banks so they are not at a disadvantage. Now everyone is free to mark their toxic assets as they please. This will truly help us free up credit - not!

http://www.bloomberg.com/apps/news?pid=20601087&sid=aElymhLgAaK4&refer=home

This is just great. Now in some respects I can appreciate that mark-to-market does not work too well when the only sales are at distressed fire-sale prices. Nonetheless, I assume most financial institutions are being liberal in putting assets into Tier III, i.e. the world where asset prices are incapable of being calculated. When there is no comparison, banks are a bit free (subject to paying their auditors enough to go along) to mark-to-fantasy. Still, there is just so long they can play this game, so they want another way to cook the books and the FASB is playing along.

I may be off on a branch here, but I think we need more transparency, not less. Allowing financial institutions to hide more of their problems with accounting standards being lowered is the wrong direction, in my opinion. But hey, I am just a blogger with a small voice.

Krugman - Not an Optimist

I do not always agree with Krugman, the Nobel laureate economist, but I agree with him that this is a nasty downturn that is not over yet.

http://www.calculatedriskblog.com/2009/04/occ-more-seriously-delinquent-prime.html

I am using this as a lead up to something I posted last night but to which I did not give proper justice. Prime loans, by number, are now exceeding subprime loans in the loans seriously delinquent status. Now stop and think about this for a bit. Prime loans are typically for a higher loan amount than subprime, commonly much more. Prime loans represent a much larger number of loans than subprime. So the bank toxic assets, in my book, should be getting much more toxic. More loans at higher loan values delinquent does not bode well for banks. Nor does it bode well for all those that bought securities backed by these loans. If the banks had serious problems when subprime went under, then they really have to be suffering now.

Think about it - carefully. Prime loans are rated better and represent more money at risk. If these are going under the bank problems are getting worse significantly.

I have said on this site that I do not see a bottom until real estate bottoms. I still do not. In part this is due to the strain on those owning the homes and in part it is due to the strains on the financial institutions. Prime loans increasing in delinquencies is not a good sign to me.

Disclosures: None

Today Is A Good Day

Today I learned I am a father again. We are adopting from China a second time and this time it is a boy, which is extremely rare. He is a dapper and strapping lad, both at once. Any hoot, I will be focusing on my new family for a while so my posts will be a bit sparse. All I can really say is that I think the recent bounce is a dead cat bounce. My relative doom and gloom take has gotten less readers lately, which I assume is due to the market being up and people believing I am wrong. I am the first to hope I am wrong and they are right but the stats are not showing it.

It is late, and it was a very big day for me as I now can see my son's picture, but I will give you one tidbit to consider; prime mortgages are now leading sub-prime in numbers of delinquencies, not percentage. At the end of the day, these delinquencies in dollar terms can make subprime look small. Go figure -

http://www.calculatedriskblog.com/2009/04/occ-more-seriously-delinquent-prime.html

If you are not buying into this stat, please put Calculated Risk on your must do list. The stats there daily, including today, tell me the bottom is at best in sight but nowhere near.

http://www.calculatedriskblog.com/

Disclosures: None

Let The Games Begin

When Geithner announced his plan, which I refer to as TARP II, one of my earlier thoughts was that if I were the banks with the toxic assets, I would form a plan to bid on each others paper. With the government taking 93% of the downside risk and only 50% of the upside, why not? So, you say, nonetheless, why would the banks do this and add on more toxic debts. Well, let's just run through a "hypothetical" example and see why.

Lets take a few made up institutions, such as GreedyGroup, Jumpin' at Morg Money, Watchoveryourmess and Pits Forgo. They each carry, in this hypo, their toxic assets at 50 cents on the dollar but they each know the assets are worth 25 cents on the dollar at best. Yet they agree amongst themselves to bid up the auction on each other's toxic debts to the point where whoever buys is paying 80 cents on the dollar. The government is paying most of this and the buyer only has a 7% risk of loss. Let's assume that each bank agrees to buy $100 billion in toxic assets from another of their brethren at 80 cents on the dollar. In theory they have each - as a seller - now gotten $80 billion in proceeds for assets booked at $50 billion but really only worth $25 billion. In other words a benefit of $55 billion overnight - not to mention the ability to falsely raise the market price of other toxic assets on their books and hopefully attract foolish buyers.

Now mind you, the selling bank also needs to be a buying bank from another bank. So they buy $80 billion and lose their entire investment, which is 7% of the investment, which is 7% of $80 billion - $5.6 billion. So the gain on the seller side is $55 billion and the loss on the buyer side is over 5.6 billion. Net gain - $49.4 billion. And they owe the U.S. government and taxpayers how much - $0. You can guess who gets the loss in this scenario.

Now obviously Geithner is too smart to let this happen (I hope) so they will do things to prevent it. Nonetheless, those very smart minds out there that figured out how to make money from increasingly sophisticated financial products that caused this mess are now actively figuring out ways to game the government's plans for a rescue. They are figuring loopholes to transfer massive taxpayer dollars from our pockets to their pockets. This truly makes me ill. Did I mention I do not like Geithner's Plan -or lack thereof. For multiple ways this system is being gamed, I refer you to this link. I say put all these companies under, sell the pieces off and hang the executives out to dry.

http://www.businessweek.com/magazine/content/09_15/b4126020226641.htm?campaign_id=rss_daily

Nonetheless, despite the possibility of it being gamed, some who might have been interested in the Geithner plan are coming our squarely against it. They point out that the touted leverage may not be what was touted for private investors. As a taxpayer, I hope so.

http://www.nypost.com/seven/04022009/business/no_private_hedge_162512.htm

Have We Hit The Bottom

I have been saying not, but for this post I will let you decide for yourself. Calculated Risk has been posting a Four Bad Bears chart on a regular basis. If you look at where things stood in The Great Depression about this point in the process, I am sure they were optimistic the worst was over. They had a nice bounce too.

http://www.calculatedriskblog.com/2009/04/markets-another-day-at-casino.html

Nonetheless, I have to admit, some of the key indicators are giving off better signals as of late. Credit markets in general seem to be better. After trillions in aid they should be. The question I have is "Do we need more credit?" Yes, certain corporations are desperate for credit just to continue normal operations. Plenty of businesses, even in good times, rely on credit as the lubrication that keeps the machine going, so we need that to be there for viable corporations. But beyond this, pretty much everyone else is in a position where they need to further deleverage. So, again, I ask, do we really need credit to save the day.

Banks Betting Against Themselves

So Citigroup says to avoid bank shares as they have peaked. This is bad news. But the the rules on them marking their debts to market are being greatly relaxed and the banks are having a nice boost. Suddenly the advice, from Citigoup, is wrong as the bank shares jump. But suddenly, we all have to be even more afraid as there is less transparency. Just when someone at Citigroup is saying not to buy their shares news comes out that leads to people to foolishly want to buy them. Are the shares really any better off now with less transperancy? Go figure.

http://globaleconomicanalysis.blogspot.com/2009/04/citibank-to-investors-we-suggest-you.html

You decide for yourself if the news is good or bad. I admit it is mixed. I did buy more put options today - though I was a bit hesitant in doing so. Signs are getting more mixed, which is a good thing overall.

Disclosures: None.

We Will See

My wife says I am an optimist. She does not read my blog. I do believe optimist describes my nature, but I suspect you may beg to differ. I have been called chicken little, but that was late last summer when I was predicting doom-and-gloom. You can figure for yourself what has happened since then.

Notably past performance is no indicator of future performance. Look at three or four years of performance at the main financial companies lest you have any doubt about this statement. Bottom line, I am just as apt as the next guy to be wrong. And negative reactions to my negative reactions are perhaps correct. I have no lock on the right direction here, just passing on what I am seeing.

What I am seeing is a job loss in March of 742,000 jobs. The only thing surprising to me is that most predicted we would do better than the February number, which I believe was barely over 700,000. If you believed things turned in March (like the market believed) then I can see why jobless expecations changed. Yet the proof is in the pudding.

Not all is lost by any means. As the linked Bloomberg article notes there are some glimmers of light. These are not yet spelling a bottom for me, but you decide on your own:

http://www.bloomberg.com/apps/news?pid=20601087&sid=aNz_BL.tu7yw&refer=home

Here is perhaps even better news - Nouriel Roubini, one of the most prominent doom-and-gloomers, thinks the past quarter was the worst we will see. The rest of this year will still be recession but not as bad. After that he sees a long, very slow climb. It is "L" shaped but we may be at or near the bottom of the "L," according to Nouriel. Not the brightest news, but darn right cheery for Nouriel.

http://finance.yahoo.com/tech-ticker/article/223197/Roubini-Go-Ahead-Keep-Dreaming-of-That-"V-Shaped"-Recovery?tickers=xlf,%5Edji,%5Egspc

Car sales are also showing the possibility of a bottom. After all, there is just so long people can keep those old cars running - though there are obviously a lot of good used cars out there. Hardly decisively in terms of a bottom, but better than a decisive fall.

http://www.calculatedriskblog.com/2009/04/auto-sales-ray-of-sunshine.html

And did I mention the market was up today after a rough start. Good recovery after a bad jobs report. Nonetheless - here it comes - I have my doubts that the worst is behind us. Yes I know unemployment usually peaks six or so months after the market bottoms, so I am not focusing on that stat. In other words, the unemployment numbers are not a leading indicator. So let's ignore these for a moment.

Chinese manufacturing is down for eight months in a row. If you are in competition with them, perhaps a good sign, but the competition is doing no better.

http://finance.yahoo.com/news/Survey-finds-Chinese-apf-14808967.html/print

And just a smidge of corporate debt was downgraded by Moody's in the first quarter. That "smidge" totalled $1.76 trillion (with a T). That is a lot of downgrade in my book. Indeed, it is the worst default rate since WWII. Go figure.

http://www.reuters.com/article/marketsNews/idINN0142700320090401?rpc=44

And I must say that Moody's was rather moody in March. They report that credit card charge-offs were also at record highs. A sixth consecutive month of increases and the highest level in 20 years. Yep, that bodes well for a bottom.

http://www.reuters.com/article/companyNewsAndPR/idUSN0150570720090401

I mentioned yesterday GM and Chrysler's imminent bankruptcy filings. Some of the other car makers are not doing much better, despite some signs of a bottom in car sales.

http://www.calculatedriskblog.com/2009/04/ford-us-march-sales-fall-409.html

Where I am coming from has a few key items. First, roughly two thirds of our GDP, before the recession, was based on consumer spending. This was during a period when people used their houses as piggy banks, when millions more were employed than now and when credit for anyone who could fog a mirror was plentiful. We are now in a period where houses continue to lose value (so the piggy bank is not only empty but asking for money back), where incomes are stretched (if they exist at all), when credit is not being extended even to the worthy, and where the vast majority of Americans desperately need to deleverage from record high levels of debt. Even with stimulus, consumer spending ain't happening going forward at levels it did for many years, if not decades, to come - AND IT SHOULD NOT DO SO. I know the government wants us to continue spending to save the economy. At best we should slow our individual deleveraging but not stop the process.

Second, we built many mega-financial institutions off of derivatives, like mortgage securitizations, and all sorts of other fancy financial instruments. This financial market is gone and not about to return. It was highly profitable for the institutions, but it is now gone and not to return until all present memories have dissappeared. After all, we enacted laws in 1908 in response to the 1907 recession that made instruments like credit default swaps, i.e. bucket shops (look it up), illegal. During the last few months of Clinton's reign, Congress enacted the Commodities Futures Moderniztion Act of 2000, which Clinton signed into law in December 2000. It cleared the air for CDSs to be legal, for bucket shops to return with a vengence. We basically had legal, unregulated instruments, that allowed people to bet on the direction company bonds or other debt would take but with no proprietary interest in same. And bet they did, to the tune of $62 trillion by some estimates. Right - no problem here. It took us nearly 100 years to forget why we made made bucket shops illegal and hopefully it will take at least that long the next time. Don't believe me, believe Eric Dinallo, the New York Superintendant of Insurance, who recently tried to regulate certain CDS positions as insurance.

http://www.nakedcapitalism.com/2009/03/eric-dinallo-we-modernised-ourselves.html

And housing needs to bottom. There are signs that we are close, but there are other signs we are not there yet. I have posted these here yesterday and today. We will not get to the bottom of the economy until housing reaches bottom. I suspect that getting there will take a bit more time. With Alt-A mortgages and Option ARM mortgages coming to peak, with unemployment increasing drastically, with house prices continuing to decrease, I do not see a bottom in housing until late 2009 or early 2010. It could even be later in 2010. That to me will spell the beginning of the end.

After that I agree with Nouriel - the climb back will be very slow. I do not view it so much as an "L." recovery. I view our current "recession"as a correction. We are getting back to where we need to be. When we get there, the "L" will only become a "V" if there is some major economic significant gain to be exectected overall, but this is not realistic. Still, I think the economy will simply go back to a realistic level and slowly gain from there - slowly but surely. We will start to gain but from a more realistic, corrected, base. Let me be clear. If the fictional market was at 10,000 at peak and that was a false peak, perhaps the new reality market figure is 5,000. The reality may be that 5,000 is reality for our current economic condition. And going back to 10,000 could take 2, 5, 10 or so years.

Disclosures: None

Just a Few Highlights

• Markets had one of their best months ever last month, but CDS prices on major banks returned to a new high. Does this seem consistent to you?

http://baselinescenario.com/2009/03/31/will-the-real-geithner-plan-please-stand-up/

• Case-Shiller shows house prices off sharply in January, not much of a surprise.

http://www.calculatedriskblog.com/2009/03/case-shilller-prices-fall-sharply-in.html

• ADP unemployment numbers for March at 742,000, significantly over expectations and February numbers. Not a record in terms of percentage but the number is a record high.

• Obama supports government backed Chapter 11 for GM and bankruptcy for Chrysler. This could be the end for Chrysler.

• The Organization for Economic Cooperation and Development (OECD) has its economic forecasts out and they are more pessimistic than the "more adverse" version of the stress test being used by the U.S. government on financial institutions. Go figure:

http://www.calculatedriskblog.com/2009/03/comparison-oecd-and-more-adverse.html

Disclosures: None

Doom-And-Gloom Returns Front And Center

I apologize for being radio silent for the past few days. Guests in from out of town, busy at work, letting people come back to reality - the usual excuses. So if you are reading this you obviously read a lot about this stuff, so I will skip the obvious. No need to talk about how Obama took GM and Chrysler over the coals a bit. No doubt to scare a bit of God into the bondholders, stockholders, workers, pensioners, and the like. In any event, I continue to believe that a government backed bankruptcy is the way to go. A new twist I heard - on the government guaranteeing warranties - came as very welcome. After all, what is the difference between an airline going into Chapter 11 and GM doing so. Airlines have bankruptcies all the time. We are used to it and it saves thousands of jobs. So why would an auto Chapter 11 be any different? The warranty, that's the difference. Most flyers have at most the fear of losing frequent flyer miles in an airline bankruptcy, but someone spending, 20, 30, 40 or more thousand on a car wants to know that the warranty will be honored. Looks like the government is willing to cover that base. Nice move.

Banks Profitable in January and February

I know this is old news but I have spoken to other people who scratched their collective heads when they heard this. After all, were they banking on another planet. The U.S. economy continued to suck during that time period, perhaps much worse than before. There was no big objective reason anyone could point to on why these massively money losing companies suddenly became quite profitable for a couple of months in the midst of a once-in-50 (if not 100) year- recession. Thus the head scratching. Nonetheless, the news supplied a nice market bounce.

Before I get to one possible explanation, let me note that most these banks have more recently reported that things turned south in March, so their first quarter results overall may not be as good as expected. Let's dwell on that for a moment. During January, February and the first week or so in March, the S&P went down say 25-26%, which is the time period when the banks reported a profit. Then in March the market had one of its greatest one month bounces ever. Yet the banks reported a turn for the worse in March. Hmmm. Seems counter-intuitive. Markets down drastically, banks up. Markets up drastically, banks down. That works for me - not.

So here is the possible explanation that I found. At least someone is saying that the major banks profited nicely from AIG giving them taxpayer dollars earlier this year. You see, AIG is the provider of many billions of dollars in CDS protection. These are toxic assets on AIG's books so they seem hell-bent on taking them off the books while the taxpayers are willing to pay for it to do so. So AIG is buying this "insurance" protection back from those that bought it - known in insurance parlance as a commutation - regardless of cost. After all, the taxpayers are paying so what the heck. The beneficiaries of this largess has been in part some banks that could book profits. That is one time profits at the detriment of taxpayers, but profits nonetheless. Go figure.

http://www.nakedcapitalism.com/2009/03/guest-post-banks-were-profitable-in.html

So if you think I am down on banks, look at what traditional doom-and-glommer Wolfgang Munchau, has to say. A good bit worse than his usual predictions. It is not pretty:

http://www.nakedcapitalism.com/2009/03/guest-post-banks-were-profitable-in.html

Did I mention that the 23rd bank went under for this year last Friday. The only surprise here is that it was only one bank.

And let me end with the end of the Hummer. Not for certain yet, but there seem to be no buyers and Hummer seems destined for a bitter end. Nothing like the head of GM getting axed to get its least liked gas-guzzling brand getting axed. There is symetry in the world after all.

http://www.calculatedriskblog.com/2009/03/end-of-gm-hummer-on-tuesday.html

Disclosures: As I noted last week I did some put options. Just a few thousand dollars worth at what I thought was the peak of what I perceived as a dead cat bounce. None of the stocks I have noted here today. I just think you should know that some of my investments right now do better when the market is down. I did, however, lose money today as I also have equity investments. The options are a hedge.