Moral Hazard? - Assuming Morals Still Exist.

Let me first note that I told you so. The time for me to say this has not arrived yet, but it will so I wanted to get it out of the way. We are in a new period of irrational exuberance. I think irrational based upon the stuff I have been posting. At this point, any exuberance I believe is irrational.

Nothing Moral About It!

Here is an interesting bit I noticed today and I am sick. This shows that institutions issuing subprime loans did $370 million in lobbying over the past decade. That is an insane amount. But when you are doing about a trillion in idiotic loans and do not want your business regulated, you go to extremes. Most of the originators of these loans are now bankrupt but were owned or financed by several of the big players that just came out of the stress tests and that have gotten taxpayer dollars. You know, like Citigroup, JP Morgan, Goldman, Wells Fargo and Bank of America. So much for moral hazard.

http://www.ft.com/cms/s/0/ab5cf9aa-39b7-11de-b82d-00144feabdc0.html

And talking about moral hazard, it is receiving far too little attention in this crisis. Let's say I am a regional bank, say Good Bank, and I did not do subprime and maintained good underwriting policies. Despite my good business practices, I am suffering as the economy is going through a crisis that even good underwriting would have a hard time predicting. So I am suffering. Yet I am reading daily about uber-banks that created all these derivatives, that did all this subprime lending, that committed all these sins, and they are going to do fine with the government refusing to allow them to fail to the tune of trillions. And this false government support is unfairly benefiting those who got us here. So I am pissed off as Mr. Good Bank because I have played by the rules and this - even after the discovery of the problems - has put me at a competitive disadvantage. "Screw this, I am not playing by the rules going forward."

I have just portrayed one aspect of moral hazard - good banks going bad. Now assuming they have good management, this will not happen, but it is a risk. The more obvious risk is for those that got away with it. Sure their shareholders had a hunk of pain, but the execs that orchestrated this mess did quite well and the companies are allowed to rise from the dead and repeat - in time - their indiscretions. Sure they will play nice for a while, but then the next wave of financial innovation begins. And I for one have not seen a lot of new regulatory proposals coming out just yet to prevent this happening again. Perhaps those hundreds of millions in lobbying dollars are still achieving their desired effect.

It is difficult to talk in terms of moral hazard when no one has any morality. I hope people - and companies - learn from this mess, but the government is doing its best to teach the companies the wrong lesson.

The Stress Tests

I do not think the tests actually were assuming enough stress, but they are - unofficially - in. If you believe they are accurate and the banks need no more capital than what is being said, good luck with that. The dollars in the linked chart are based upon "leaked" data. Leaks? I am shocked!! If I had the Casa Blanca clip I would link it here.

http://www.calculatedriskblog.com/2009/05/stress-test-table-morgan-stanley-needs.html


Foreclosures at a Bottom - Me Thinks Not!

I noted yesterday that the somewhat distant - as in 2010 and 2011 - future has some nasty surprises in terms of option ARM resets. And here is a bit of a Catch 22 for you; right now interest rates are "as low as they go." Should the economy rebound, which is what everyone seems to be banking upon, then the expectations are that we will get to significant inflation, if not hyperinflation. Now I am refinancing for a new fixed rate mortgage, so I will be fine (not my bank) but all those ARMs that have reset this year and next at lower rates are going to start shooting through the roof on rates and defaults/foreclosures will again shoot through the roof. Seemingly, there is no way around all those subprimes. Any hoot, here is a link that notes our current problems are still there.

http://www.calculatedriskblog.com/2009/05/foreclosures-2nd-wave.html

Disclosures: I bought more put options today. Those I bought last month are all down significantly. I never put much money into these but I will be buying more this week if the market continues to climb. It's that "money where mouth is" thingy. This is not, by the way, investment advice. It is rather the opposite. I am making a very risky bet.

One More Time

I hate repeating myself, but I do not see the economy at bottom just yet, so in some respects I will keep repeating myself until either other people wake up to this reality or something changes to wake me up.

The markets were down a bit today and, according to Bloomberg, they we down due to fears of the stress test results. I don't fear them; I fear what they hide. I fear that a reported 10 out of 19 banks failed when the tests were not at all stringent enough. I fear that the government will soft-pedal the results to make them bad enough to have a tad of credibility but not so bad that people run for the exits. Don't buy my word for it, others are saying the same, including Nouriel Roubini. Nouriel has been complaining for weeks on how the worst case scenario in the stress tests is already rosier than reality. Go figure?

http://www.nakedcapitalism.com/2009/05/richardson-and-roubini-call-for-bank.html

I noted yesterday that I do not see a recovery of our economy any time soon as 70% of our GDP is consumer spending and that is going to suck wind for years to come. One point I made was that wages were stagnating at best and likely decreasing - not to mention unemployment, capital destruction and the like. Michael Shedlock provides us with a good bit of detail on this point. As he points out, wages are contracting in the U.S., U.K. and Japan - three major economies. This cannot be good for these countries' economies or the multiple countries that supply them products.

http://globaleconomicanalysis.blogspot.com/2009/05/wages-contract-in-us-uk-japan.html

I do recommend that you go to the linked site as there are a couple of other significant points covered there, with nice charts. For example, Mish notes it is presently taking a significant percentage of disposable income (19%) to service household financial obligations, meaning less is left over for consumer spending - especially with people starting to save. Here is one very telling chart from the post showing that we are drowning in more debt now than ever before. Gee, I see a recovery around the corner. Yep, there it is.

https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiyEj8RHEoNCto_2i6Lz38ojBXxzsLEYl3bbTPo15gHS644PFKOr_NkGmreApGqz0V5oCVGPgCbMgaBq9iRQzNq195lB2nwiO08Ivf49Eswk3v-Qe3yw_k3VB3GZLxmqk55W3dY9aEsSJFj/s1600-h/Total+Consumer+Credit.png

In case you are wondering whether the individual strain on spending in the U.S. is having any significant impact on GDP growth, the answer is a definite yes! Nominal GDP growth has turned negative YOY for the first time in 50 years. And the markets have gone up significantly since the March 9 bottom. Go figure?

http://suddendebt.blogspot.com/2009/05/one-chart-plus-one-word.html

So what do we do to deal with the most significant debt crisis ever to face our country? You got it, we incur more debt. Now this debt is on the government level and it is getting seriously over the top.

http://www.nytimes.com/2009/05/04/business/economy/04debt.html?_r=1

Now if the government were taking on this debt to give the money to taxpayers so they can pay off debt and deleverage, that would be one thing. But precious little is going to individuals to deleverage. Rather it is going to the bastards that got us here so that they can promote more lending and individual debt. Think about that long and hard. I have and I simply cannot convince myself of the sense of it. If instead we gave money to individuals so they could deleverage then they would not need to spend their own increasingly sparse dollars to deleverage. This is not perfect, but at least new debt on the government level is removing debt from individual balance sheets. At least those paying for it (taxpayers) get the benefit.

I have said here often that Americans hunkering down is a good thing. I just said yesterday that Americans saving is tough on the economy in the short term but good in the long term. I stand by these comments, but let me add a caveat. If we all start selling what we have to make money and start saving too much all at once and all start spending significantly less, it does run the risk of creating a dangerous spiral. Deflation starts in as prices drop to try to lure an ever more frugal consumer. Yet deflation makes the debt more onerous. The cycle is one that is difficult to break when it starts.

Thus the occasional statements by the Administration that Americans should not stop spending and its desire to get credit flowing again. They should explain this a bit better and realize Americans need to deleverage, not build debt, though we probably need to do it slowly to avoid potentially dangerous spirals. The attached link, while a bit long, explains this in much better detail. This is something important to understand, so I recommend the full read of the linked article. It goes through a number of other interesting points but it ends with a discussion of the possible spiral. We are my friends in very delicate times. Damned if you do, damned if you don't. Yet the markets are up significantly since March 9. Go figure?

http://www.debtdeflation.com/blogs/2009/05/04/debtwatch-no-34-the-confidence-trick/

Still, given the danger of a spiral forming if Americans seek to save too much and deleverage too much during a time of reduced jobs and wages, you would think the Administration would be doing everything it could to help the average "Joe the plumber" to deleverage (and pay his taxes), so that Joe could perhaps spend a bit more of his income - as small as it might be. If the government incurs debt for individuals to reduce debt, that is not perfect but it is better than the government incurring massive debt to support more lending. Moreover it is significantly much better than taxpayer dollars going to big bank dividends, executive bonuses and the like. Even if all the government largess to banks led to more credit availability, we do not need lending, we need the reverse. I am truly praying that common sense sets in for the Administration soon.

Real Estate - At a Bottom?

On occasion I have noted I see no true bottom until housing bottoms. With job losses, significant individual debt to deleverage and a variety of other ills, a housing bottom is just the beginning of what we need. Nonetheless, it does not look like we are there just yet even on housing. My favorite site on housing, and some other issues, Calculated Risk, notes some recent reports confirming same.

http://www.calculatedriskblog.com/2009/05/homebuilders-on-housing-market.html

Part of the problem is that just when we feel like we have reached a housing bottom, which I anticipate toward the end of this year, we will enter into the peak years for option ARM resets (adjustable rate mortgages that let the lenders pay less than interest), which will lead to more foreclosures and more downward pressure. This is a major issue for Wells Fargo and the likely reason it will be one of the 10 banks needing more capital.

And last but not least, I leave you with a very much worth while link to Zero Hedge. They go through in very nice detail some of my concerns. I agree with them on pretty much all their points. It is a long post by them but well worth the read. Well balanced, informative and educational - just what I like.

http://zerohedge.blogspot.com/2009/05/shooting-shoots.html

And so I feel I am repeating myself. At least as you can see from the linked materials above I am not alone in my thoughts. Still, I think people are tired of the negative news and would prefer to hear media lies to make them feel better. At least that is one comical take on the matter:

http://www.theonion.com/content/news/nation_ready_to_be_lied_to_about

Disclosures: None.

Inflating a Bubble

Let me do a brief post here as no one will read me anyway because I think we are in a false, prolonged bear bounce due to a variety of factors. My bigger fear for those that may listen is I have no idea how long it might last. It could be days, months or perhaps even years, though I suspect reality makes the latter unlikely. Still, I am not willing to discount the possibility that all this massive stimulus around the world will either kick the can substantially down the road or, perhaps, build a new bubble and bubbles typically take a few years to build and pop.

So let's assume we are in the process of building a new bubble to burst. So what? Well, our current economic demise is in part due to Greenspan (sorry Alan) inflating our current debt bubble to deal with the dotcom bubble bursting. So U.S. citizens have for most of the past five years been spending massively with debt - debt due to easy credit, debt tied to inflated home values, debt that exceeded their ability to pay - in a word, massive debt (okay, that's two words). America needs to deleverage massively on an individual level.

On the corporate side (banks and certain financial institutions aside) we came into this recession pretty well capitalized. Nonetheless, most corporations do need credit on a regular basis to operate, simply to keep things operating properly. So a credit thawing is needed for basic corporate America to operate properly. To me, however, this should be through smaller regional banks that did not cause the mess, not the evil players we are subsidizing.

For individuals, however, we did not come into this well capitalized. We were spending well over our means using the house piggy-bank. That piggy bank is getting very thin right now and will not support more lending. Add to us having way too much individual debt the concept that job losses are increasing, incomes are decreasing, collateral - like homes - is decreasing in value and people with jobs are working less hours and worried about keeping them, then you know individual deleveraging will continue. And let me add to this that this deleveraging is an extremely good thing for our country and for the people doing it. Painful in the short to medium term, but good overall.

Perhaps, also, painful in the long run. What do I mean by this? We are even after paying off debt returning to a place where we save 5% or more and do not build debt. If incomes do not take off - and they won't - then the future means a significantly lower level of spending money. We need to pay off debt and increase savings all on reduced income. This truly sucks but in the end we will achieve new balance.

So think about it. Less pay, reducing debt, increasing savings - what does all this mean to the economy? In my book it means an economy that sucks wind for a while. You are free to figure out your own take on it.

Let me add another point to the equation. Personal incomes in the U.S. have been overall rather stagnate this millennium. They are going down now but even in the good times on average were not going up.

So let me stop by simply noting Geithner cannot wave his magic wand and solve our problems. I have gone on at length on how I think he is doing the wrong thing, as in more debt does not solve - for the long term - a debt-based crisis. I do hope we wake up soon and start making some smarter moves. Unfortunately politicians need to focus on "fixes" that will work in two to four years, the election cycle. The economy is not tied to the same cycle.

One request to Obama, as I conclude. Please give Paul Volcker more say in what is happening. He is less beholden to Wall Street and more concerned about what happens to main street. If you are truly concerned about "change," you have no choice.

Disclosures: None.

Sorry Folks, But the Pain Ain't Over Yet

I keep looking for signs of hope that the worst is behind us, and there is anecdotal evidence that it is, but I don't like anecdotal evidence. Rather I like - let me correct - I love data and statistics. Why do I love data and statistics? Because they do not lie. CEOs of top banks lie, politicians lie and many others giving opinions lie. Data, if read properly, does not lie. So, my friends, why is the data leading me to my continued pessimism?



Let's begin with option ARMs (Adjustable Rate Mortgages). In case you do not know what an option ARM is, it is an adjustable rate mortgage that for an initial period, before reset, allows the mortgage holder to take the option of paying less than interest. Also referred to as reverse amortization. In other words, the loan principal increases during the initial period before the reset, allowing people who cannot really afford a home get by for a few years paying minimal payments, but when it resets they need to pay interest and principal based on an amortization schedule for the remaining life of the loan. Translation - even with currently low interest rates their payments are going up significantly. Now add to this equation job losses, housing prices down up to 50% and more in certain areas and all the other stresses on our economy and you have more trouble on the horizon. You figure for yourselves how many of the option ARMs will get paid off or go into default. The linked site has a nice chart on how the option ARMs seem to be peaking in resets in 2010 and 2011 (near the end of the article). I did a post the other day on how we are in the eye of the hurricane here. It may be a big eye, but it is an eye.



By the way, the good news in the linked article is that other adjustable rate mortgages are probably - this year at least - resetting to lower rates, which is a very good thing. Those who have enough equity to refinance at a fixed rate are going to do well, but I suspect that is a very, very small percentage of those with ARMs. For the rest, if inflation takes off a few years from now, as some suspect, those rates will sky-rocket. Another eye-of-the-storm factor to consider.



http://globaleconomicanalysis.blogspot.com/2009/05/arms-reset-crisis-revisited.html



I am doing a footnote here on commercial real estate loans, which are now sucking wind and credit card defaults that are mounting. Just a couple of asides to consider in determining whether we are past this.



So Let's Look at Consumer Spending



Consumer spending is 70% of our GDP in the U.S. Government is 20%. How much can that 20% make up for deficits in the other 70% - not that much is my answer. And more importantly, the government is wasting its time and our money focusing on the financial sector as opposed to other stimulus for the guy on the street. Don't get me started but the government spending literally trillions on unfreezing credit seems to me a bit odd when our current problems are due to too much credit. The linked articles agree -please read them.



http://suddendebt.blogspot.com/2009/04/culprit-revealed.html



http://suddendebt.blogspot.com/2009/04/crisis-part-two.html





The good news (not for the government) is that U.S. citizens are deleveraging. The savings rate continues to climb despite job losses. The government should be supporting this and spending their trillions of our dollars for long term domestic sustainable job support (you know, like supporting new green technologies, college tuition support, infrastructure and the like) versus spending trillions on the *&^%$'s that got us here. Nonetheless, whether the government knows the right thing to do, individuals do. Saving rates are on the increase even while job losses continue.



http://suddendebt.blogspot.com/2009/04/culprit-revealed.html



Bottom line - the government is doing absolutely the wrong thing. They are supporting those that created this mess (with significant moral hazard) to prompt more credit when the root of our problems is too much credit. We need to flush the system and get rid of the credit spending but instead we are pushing for a new bubble. At best, if it works, we are kicking the problem down the street. Not a good plan - not at all!!



The other day I mentioned I do not like Geithner or Summers. That is not an understatement. Pleeeeeeeeeease Obama, put Volcker in charge. I truly implore you to do this. If you like Summers and Geithner, please take the time to read up on them. They are insiders on the banks we are supporting with obscene amounts of money, which makes me sick. These people need a public flogging, not taxpayer support.



And in case you missed it, here is my tribute to Dr. Seuss, were he alive today, turned 105 last month. It is on point and I think the Dr. would agree:

• I do not like Geithner,
• I do not like Summers,
• I do not like them,
• I do not,
• I do not.
• They spend my money,
• They give it away,
• They think that is funny,
• And I have no say.
• They like big banks,
• They like them a lot,
• They give them my money,
• They give all I got.
• I would not help banks,
• Not give them a dime,
• I would not help banks,
• Even give them the time,
• I would not help banks,
• With all the subprime,
• I would not help banks,
• Their mess is a crime.
• It is their problem,
• They made their own bed,
• It is their problem,
• Their stock price is so red,
• It is their problem,
• You heard what they said,
• It is their problem,
• Yet they score from the Fed.
• The TARP is bad,
• The TARP is sad,
• The TARP is making me,
• Oh so mad!
• PIPP PIPP hooray,
• I hear them say,
• PIPP PIPP hooray,
• And again I pay!
• We give banks money,
• So they will lend,
• We give banks money,
• So they will spend,
• But we give them the money,
• And they pay dividends,
• Please tell me Obama,
• When it all ends.
• The toxic assets,
• They must be bought,
• They must be bought,
• For a lot,
• And then the bank stocks,
• Will be so hot,
• And yet the economy,
• Still goes to pot.
• I do not like it,
• I like it - not!
• I do not like it,
• Please make it all stop!!
• I do not like Geithner,
• I do not like Summers,
• I do not like them,
• I do not, I do not!!!http://www.nakedcapitalism.com/2009/04/knives-are-coming-out-for-geithner.html
  

Disclosures: None.

Rejoice - Consumer Spending Up!!

Oh joy, oh joy, consumers are going back to their spending ways. Now some might say this is a good thing. Obviously the market said this today. I, on the other hand, think it is in the medium to long term a very bad thing. I read a very good piece today from RGE Monitor (Nouriel Roubini's blog, which has a number of well educated and versed authors. I highly recommend going there and signing up. It is a free, and very informative. They send you a great email or two each day.) on the imbalances in part attributed to the so-called Brent Woods 2 system. At base, certain export countries - Asia, Middle East and the like - have been funding the U.S. and certain European countries to enable us to buy more products than we can afford. RGE puts a lot of nice economic terminology around it but at the base, these countries for years have funded our debt spending to buy their stuff - oil, consumer products, and the like. We have been spending more than we make buying this stuff, in part due to a housing bubble and in part due to easy and low rate lending (partially made possible by our trading partners). So the problem in large part has been Americans spending too much, and the market now celebrates that we are gradually returning to those unsustainable ways. I am not liking this.

I have written on numerous occasions on what I call the new reality. Over the past few years we have lived in a ferry-tale world. We have been spending more than we make and that has been tied to easy credit and an ever-expanding household piggy-bank (otherwise known as housing prices). We have had one heck of a good run. But it has been a run with a false premise. We could not afford it and now, with debt built up and housing prices down 15-50% across the board, we do not have the collateral to support it. Even if we briefly start spending again, this will disappear - it must - it has not choice. We have to live within our means and, to properly recover, must live well enough within our means to pay down debt. Think about it - the baby-boom generation just lost 30-50% of their retirements and most probably did not have enough saved anyway. Do you really think these people are about to go on a sustained spending spree? No, they need to save every cent the can (I am) to restart their retirements. And these for the most part are people still at the peak of their earnings.

We need to consume less and the countries that sold to us need to focus on domestic consumption, which they need to support through domestic stimulus, versus supporting exports to debt-laden Americans. We are like recovering crack addicts and the government wants to give us more drugs to fix our pain. Eventually, we need to get off the drugs. We need to go straight, as in without a debt addiction. Time to get real and the sooner the better with our own economy and the world economy. The new reality is upon us. The countries exporting to us need to understand this as much as we do. It is a new and necessary dynamic. You might call it the new reality.

I will be the first to admit that my predictions on us not yet being to a true bottom might be wrong. Yet, more importantly, even if we have seen a bottom, I do not see us escaping it any time soon. To me the bottom is the new reality. It is where we would be - should be - absent the last couple of bubbles. With job losses and real estate prices still dropping, I can still see us hitting a new bottom, but there is a real prospect that the massive government spending will support a false bottom and even provide a false and significant bounce. I simply suggest you study the long term fundamentals before getting all excited. If you want to play the short term possibility of a stimulus bounce, go for it at your own risk. It might happen. Nonetheless, I suggest the reality will keep us close to the range we are in for the medium range at a minimum.

Disclosures: None.

Stess Tests In Fact Causing Stress

I wrote a couple of posts last week questioning whether the government stress tests were really going to test the banks. Word today is that at least a few of the 19 banks being tested will likely need to raise new capital - though they are protesting the results, so who knows. If the government comes out saying certain banks need more capital I will eat (some of) my words. The stress tests baseline is foolish at this point as the economy is trending towards the worst case stress tests scenarios. I am not certain where the government will come in, but certainly some banks, like Bank of America and Citigroup, are needing more capital no matter what test you use.

And talking about tests. Mr. Lewis (I use "Mr." generously) is perhaps soon to see the door at Bank of America. Given the BofA acquisitions over the past year or so, I would have voted his hide out a long time ago. Some major shareholders are waking up finally to the terminally ill condition he has caused with acquisitions. I mean if I could tell they were stupid without any due diligence then he is an idiot. Just my humble opinion, by the way. Don't shed a tear here as I am sure he has made many millions for his foolish ways and undoubtedly has a contract that will give him many millions more if he is put out to pasture. If only shareholders could figure a way to sue him to get it back. Were I still in private practice I would love to spend countless hours figuring out how to sue these (fill in your own derogatory term here) on behalf of shareholders or even taxpayers. I would even do it for reasonable flat fee just to make these (fill in again) pay for what they have done to this country and the world. These individuals need to be hung very high.

Are we hanging them high? Of course not. We are rewarding them with hundreds of billion - trillions - in taxpayer largess. I am truly sick!!

I truly hope Lewis is hung high by his own shareholders. When they have to convert the government prefered shares to common, they will be highly diluted. They cannot be happy. I am certainly not.

http://www.bloomberg.com/apps/news?pid=20601087&sid=aqtmeiUmp8ug&refer=home

Other than the true tragedy developing with a potential swine flu pandemic, there is nothing else I saw worth reporting.

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

Disclosures: None

I Do Not Like It, I Do Not, I Do Not!

I do not like Geithner,
I do not like Summers,
I do not like them,
I do not, I do not.

They spend my money,
They give it away,
They think that is funny,
And I have no say.

They like big banks,
They like them a lot,
They give them my money,
They give all I got.

I would not help banks,
Not give them a dime,
I would not help banks,
Even give them the time,
I would not help banks,
With all the subprime,
I would not help banks,
Their mess is a crime.

It is their problem,
They made their own bed,
It is their problem,
Their stock price is so red,
It is their problem,
You heard what they said,
It is their problem,
Yet they score from the Fed.

The TARP is bad,
The TARP is sad,
The TARP is making me,
Oh so mad!

PIPP PIPP horay,
I hear them say,
PIPP PIPP horay,
And again I pay!

We give banks money,
So they will lend,
We give banks money,
So they will spend,
But we give them the money,
And they pay dividends,
Please tell me Obama,
When it all ends.

The toxic assets,
They must be bought,
They must be bought,
For a lot,
And then the bank stocks,
Will be so hot,
And yet the economy,
Still goes to pot.
I do not like it,
I like it - not!
I do not like it,
Please make it all stop!!

I do not like Geithner,
I do not like Summers,
I do not like them,
I do not, I do not!!!

http://www.nakedcapitalism.com/2009/04/knives-are-coming-out-for-geithner.html

Disclosures: None!