---
© 2008 Michael Cale
September 30, 2008
September 28, 2008
Two Newspapers In One
Today's New York Times points out that President Bush is not a conservative in the traditional sense. Major issues include the facts that he has been an advocate of big government, chronic overspending, an expanded bureaucracy (Homeland Security), and a creator of new entitlement programs (Medicare prescription drug program).
President Bush has even been called a socialist for supporting the $700 billion bailout plan.1
But on the Opinion page (just a single page-turn away), the editorial board makes an attempt to blame the financial crisis on President Bush's support of deregulation.2
This takes a willful ignorance of history to make this claim. When Congress very nearly passed increased regulations on Fannie Mae and Freddie Mac in 2005, President Bush supported the Senate version of the bill, which was not able to overcome Democratic opposition in Committee and failed without a floor vote. This version of the bill would have put strict limits on how much debt the company could carry.
President Bush actually opposed the House version of the bill, which passed the House by a vote of 331-90. The House bill would have let Fannie's regulator determine how much limits to put on the portfolio of now-'toxic' debt.3
The limits that Bush supported would have forced Fannie May to reduce it's debt by about $1.5 trillion. Instead, without the limits, the bad investments continued to pile up.
See A Failure of Government
---
President Bush has even been called a socialist for supporting the $700 billion bailout plan.1
But on the Opinion page (just a single page-turn away), the editorial board makes an attempt to blame the financial crisis on President Bush's support of deregulation.2
This takes a willful ignorance of history to make this claim. When Congress very nearly passed increased regulations on Fannie Mae and Freddie Mac in 2005, President Bush supported the Senate version of the bill, which was not able to overcome Democratic opposition in Committee and failed without a floor vote. This version of the bill would have put strict limits on how much debt the company could carry.
President Bush actually opposed the House version of the bill, which passed the House by a vote of 331-90. The House bill would have let Fannie's regulator determine how much limits to put on the portfolio of now-'toxic' debt.3
The limits that Bush supported would have forced Fannie May to reduce it's debt by about $1.5 trillion. Instead, without the limits, the bad investments continued to pile up.
See A Failure of Government
---
Sources:
1. Jacob Heilbrunn. Whose Conservatism Is It?.
New York Times. September 28, 2008. Pg. Wk 6.
http://www.nytimes.com/2008/09/28/weekinreview/28heilbrunn.html
2. New York Times. Don't Blame the New Deal.
New York Times. September 28, 2008. Pg. Wk 9.
http://www.nytimes.com/2008/09/28/opinion/28sun1.html
3. Stephen Labaton. House Approves Overhaul at Fannie Mae and Freddie Mac.
http://www.nytimes.com/2005/10/27/business/27fannie.html
© 2008 Michael Cale
Revenge of the New Deal
The financial Frankenstein monsters of the New Deal are coming back for revenge.
Fannie Mae and it's more recent cousin, Freddie Mac, are the giants in the current crisis.
A lesser role is being carried out by the Federal Home Loan Banks (FHLB). The Treasury has already extended an emergency line of credit the the FHLBs. There is no telling how long the FHLBs can remain solvent, if they still are solvent.
Another New Deal blunder, he Federal Housing Administration (FHA), has already been directed by Congress to prop up $300 billion worth of refinanced mortgages in an effort to reduce foreclosures and, hopefully support prices.
Initially, many of the New Deal efforts were ruled unconstitutional by the Supreme Court. But as the Depression proved to be longer lasting than anyone expected, and recovery was delayed by misguided efforts in Congress and by the Federal Reserve, the Supreme Court eventually lost its resolve and allowed these initiatives to stand.
The response to today's crisis is the government going down the same Depression-era road of propping up prices.
Only this time, fortunately, it's not the price of gold or wheat that the government is concerned with. It's the price of derivative instruments. They are termed derivative because their value is derived from some other asset.
Many of these are based on real estate assets. So when the bailout of the derivative market doesn't work, it will be a short step to trying to prop up actual real estate prices. In fact, the FHA directive is exactly that.
The effort to prop up prices during the Great Depression was so severe, that a common sentiment was
If this is inflation, more of it1.
Whether the price in question is that of wheat, or money (interest rates), or housing, the government has a long history of implementing policies that do enormous damage, despite the good intentions of those who implement them.
---
Fannie Mae and it's more recent cousin, Freddie Mac, are the giants in the current crisis.
A lesser role is being carried out by the Federal Home Loan Banks (FHLB). The Treasury has already extended an emergency line of credit the the FHLBs. There is no telling how long the FHLBs can remain solvent, if they still are solvent.
Another New Deal blunder, he Federal Housing Administration (FHA), has already been directed by Congress to prop up $300 billion worth of refinanced mortgages in an effort to reduce foreclosures and, hopefully support prices.
Initially, many of the New Deal efforts were ruled unconstitutional by the Supreme Court. But as the Depression proved to be longer lasting than anyone expected, and recovery was delayed by misguided efforts in Congress and by the Federal Reserve, the Supreme Court eventually lost its resolve and allowed these initiatives to stand.
The response to today's crisis is the government going down the same Depression-era road of propping up prices.
Only this time, fortunately, it's not the price of gold or wheat that the government is concerned with. It's the price of derivative instruments. They are termed derivative because their value is derived from some other asset.
Many of these are based on real estate assets. So when the bailout of the derivative market doesn't work, it will be a short step to trying to prop up actual real estate prices. In fact, the FHA directive is exactly that.
The effort to prop up prices during the Great Depression was so severe, that a common sentiment was
If this is inflation, more of it1.
Whether the price in question is that of wheat, or money (interest rates), or housing, the government has a long history of implementing policies that do enormous damage, despite the good intentions of those who implement them.
---
Source:
1. Garet Garrett. The Hundred Days.
Saturday Evening Post. August 12, 1933.
© 2008 Michael Cale
September 27, 2008
A Failure of Government
In 2004, Fannie Mae, the larger of the two government-sponsored mortgage buyers, was notified by its regulator that it's accounting was fraudulent. It's accounting practices for years 2001 through 2004 did not meet U.S. standards, known as GAAP.
The SEC directed Fannie Mae to restate earnings for those years. Eventually, it was determined that Fannie Mae had overstated earnings by more than $10 billion.
The regulator, OFHEO, put preventative measures in place. As described in their 2006 report to Congress:
Note that this was long after Enron had failed and Congress had passed the Sarbanes-Oxley reform legislation two year earlier that was meant to stop such chicanery.
Fannie Mae's CEO during this period was Howard Raines. He is a graduate of Harvard Law School and once served in the Carter administration and later in the Clinton adminiatration.
He was CEO during the years when Fannie Mae's accounting was substandard, which turned out to be about six years instead of the originally diagnosed four years. During his tenure he received $52.8 million in bonuses.3
But not to worry, Fannie had a regulating agency. The company was so heavily regulated that it only took six years of fraud before they were able to expose it.
The regulator did make an effort to prevent this kind of thing. OFHEO put in place "growth limits and top-to-bottom remedial actions to enhance the safe and sound operation of the Enterprise going forward."1
What the regulator didn't comprehend is that the problem wasn't just accounting, it was capital.
Despite the new policies by OFHEO, some in Congress were not satisfied and sought tougher action.
In an extremely rough summary of how a bill becomes a law - it must pass a committee vote, then a full-chamber vote. This must occur twice - once in the House of Representatives and once in the Senate. The rules on how exactly this takes place varies significantly between the two chambers.
Once a version of the bill passed the House and another version passes the Senate, a conference committee meets and tries to create a compromise bill. Eventually, if passed, this compromise bill is sent to the President. If the President signs the bill, it becomes law (for the sake of argument, let's assume it is constitutional).
In the House, a bill passed in the Financial Services Committee in 2005. It created a new federal bureaucracy, the Federal Housing Finance Agency, that was tasked with placing limits on executive compensation and establishing limits on the amount of capital that Fannie/Freddie could put at risk (and thereby limit the amount of (now toxic) mortgage paper they could purchase).
The bill passed the committee by a vote of 65-5. Eventually, the bill passed the House of Representatives easily.
A similar bill was at work in the Senate. It also esablished a new bureaucracy and expanded authority over government-sponsored mortgage buyers. It also restricted the amount of low-quality mortgages that Fannie Mae and Freddie Mac could hold on their balance sheets.
According to the Washington Post:
Unfortunately, this did not have the deisred effect of curtailing the purchasing of mortgages.
This is because the reform measure did not pass the Senate. A similar Senate bill died in committee. A ranking member of the committee (Banking, Housing, and Urban Affairs) was Senator Chris Dodd. In 2008, Senator Dodd received campaign donations of nearly $30,000 from Freddie Mac, more than any other recipient. Donations in excess of $4 million were collected from the securities industry.5
But this effort to more strictly regulate Fannie and Freddie was not new. A similar effort to tighten regulation in 2003 also failed.
The SEC directed Fannie Mae to restate earnings for those years. Eventually, it was determined that Fannie Mae had overstated earnings by more than $10 billion.
The regulator, OFHEO, put preventative measures in place. As described in their 2006 report to Congress:
Fannie Mae senior management presented an image ofWell, it couldn't be that bad, right?
the Enterprise as one of the lowest-risk financial institutions in the world and as “best-in-class” in terms of risk management, financial reporting internal controls and corporate governance. The reality was that the image presented was false. The risks at Fannie Mae were greatly understated and senior management manipulated accounting and earnings. 1
Fannie Mae’s executives were precisely managing earnings to the one-hundredth of a penny to maximize their bonuses while neglecting investments in systems internal controls and risk management ... The combination of earnings manipulation, mismanagement and unconstrained growth resulted in an estimated $10.6 billion of losses, well over a billion dollars in expenses to fix the problems, and ill-gotten bonuses in the hundreds of millions of dollars.2
Note that this was long after Enron had failed and Congress had passed the Sarbanes-Oxley reform legislation two year earlier that was meant to stop such chicanery.
Fannie Mae's CEO during this period was Howard Raines. He is a graduate of Harvard Law School and once served in the Carter administration and later in the Clinton adminiatration.
He was CEO during the years when Fannie Mae's accounting was substandard, which turned out to be about six years instead of the originally diagnosed four years. During his tenure he received $52.8 million in bonuses.3
But not to worry, Fannie had a regulating agency. The company was so heavily regulated that it only took six years of fraud before they were able to expose it.
The regulator did make an effort to prevent this kind of thing. OFHEO put in place "growth limits and top-to-bottom remedial actions to enhance the safe and sound operation of the Enterprise going forward."1
What the regulator didn't comprehend is that the problem wasn't just accounting, it was capital.
Despite the new policies by OFHEO, some in Congress were not satisfied and sought tougher action.
In an extremely rough summary of how a bill becomes a law - it must pass a committee vote, then a full-chamber vote. This must occur twice - once in the House of Representatives and once in the Senate. The rules on how exactly this takes place varies significantly between the two chambers.
Once a version of the bill passed the House and another version passes the Senate, a conference committee meets and tries to create a compromise bill. Eventually, if passed, this compromise bill is sent to the President. If the President signs the bill, it becomes law (for the sake of argument, let's assume it is constitutional).
In the House, a bill passed in the Financial Services Committee in 2005. It created a new federal bureaucracy, the Federal Housing Finance Agency, that was tasked with placing limits on executive compensation and establishing limits on the amount of capital that Fannie/Freddie could put at risk (and thereby limit the amount of (now toxic) mortgage paper they could purchase).
The bill passed the committee by a vote of 65-5. Eventually, the bill passed the House of Representatives easily.
A similar bill was at work in the Senate. It also esablished a new bureaucracy and expanded authority over government-sponsored mortgage buyers. It also restricted the amount of low-quality mortgages that Fannie Mae and Freddie Mac could hold on their balance sheets.
According to the Washington Post:
The regulator must consider the safe and sound operations of the companies and the systemic risk posed by the size and type of those holdings, the bill says.Five months later, the House of Representatives had passed legislation, by a vote of 331-90, that passed many of the proposed regulations on the GSE's4.
Those portfolios of mortgages and mortgage-backed securities, which total some $1.5 trillion, pose a threat to the financial system because they contain huge amounts of risk and require the companies - which hold relatively little capital - to take on large hedges, according to the chairman of the Federal Reserve, Alan Greenspan, and the Bush administration.3
Unfortunately, this did not have the deisred effect of curtailing the purchasing of mortgages.
This is because the reform measure did not pass the Senate. A similar Senate bill died in committee. A ranking member of the committee (Banking, Housing, and Urban Affairs) was Senator Chris Dodd. In 2008, Senator Dodd received campaign donations of nearly $30,000 from Freddie Mac, more than any other recipient. Donations in excess of $4 million were collected from the securities industry.5
But this effort to more strictly regulate Fannie and Freddie was not new. A similar effort to tighten regulation in 2003 also failed.
Among the groups denouncing the proposal today were the National Association of Home Builders and Congressional Democrats who fear that tighter regulation of the companies could sharply reduce their commitment to financing low-income and affordable housing.In the 2008 election cycle, Representative Frank received roughly $180,000 in campaign contributions from the real estate industry. That's in addition to the $175,000 he received from the securities industry.7
''These two entities -- Fannie Mae and Freddie Mac -- are not facing any kind of financial crisis,'' said Representative Barney Frank of Massachusetts, the ranking Democrat on the Financial Services Committee. ''The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing.''6
---
GAAP = Generally Accepted Accounting Principles
SEC = Securities and Exchange Commission
OFHEO = Office of Federal Housing Enterprise Oversight
Sources:
1. Office of Federal Housing Enterprise Oversight. Report to Congress.
June 15, 2006.
http://www.ofheo.gov/media/pdf/annualreport2006.pdf
2. OFHEO. Fannie Mae Facade
May 23, 2006.
http://www.ofheo.gov/media/pdf/fnmserelease.pdf
3. Kathleen Day. Study Finds 'Extensive' Fraud at Fannie Mae.
Washington Post. May 24, 2006.
http://www.washingtonpost.com/wp-dyn/content/article/2006/05/23/AR2006052300184.html
4. Stephen Labaton. House Approves Overhaul at Fannie Mae and Freddie Mac.
http://www.nytimes.com/2005/10/27/business/27fannie.html
5. Center for Responsive Politics.
http://www.opensecrets.org/orgs/toprecips.php?id=D000000163&type=P&sort=A&cycle=2008
http://www.opensecrets.org/politicians/summary.php?cid=N00000581
6. Stephen Labaton. New Agency Proposed to Oversee Freddie Mac and Fannie Mae.
New York Times. September 11, 2003.
http://query.nytimes.com/gst/fullpage.html?res=9E06E3D6123BF932A2575AC0A9659C8B63&pagewanted=all
7. Center for Responsive Politics.
http://www.opensecrets.org/politicians/summary.php?cid=N00000275
© 2008 Michael Cale
September 26, 2008
Friday Thursday Bank Death Watch
The FDIC has a long habit of only seizing banks after the stock market closes on Friday. Washington Mutual just couldn't make it that long.
The FDIC has seized Seattle-based WaMu with $307 billion in assets. The last time a bank of this size failed was Continental Illinois in 1984 ($40 billion in assets). The WaMu seizure is the largest in US history.
In a script similar to 1907, the Feds have again relied/leaned-on/pressured JP Morgan Chase to come to the rescue. The deal will cost JPM about $1.9 billion. WaMu depositors should see no interruption in service.
The cost to the FDIC insurance is expected to be zero.
It is anticipated that JPM will have to write down $31 billion in deteriorated WaMu assets.
First Bear Stearns, now this. Can the feds expect anything else from JP Morgan?
This is pure desperation on the part of the FDIC.
---
Sources:
1. FDIC. JPMorgan Chase Acquires Banking Operations of Washington Mutual
Press Release. September 25, 2008.
http://www.fdic.gov/news/news/press/2008/pr08085.html
2. Marcy Gordon, Sara Lepro and Madlen Read. JPMorgan Chase buys WaMu assets after FDIC seizure.
Associated Press. September 25, 2008.
http://biz.yahoo.com/ap/080925/washington_mutual_future.html?.v=5
© 2008 Michael Cale
September 25, 2008
Housing Will Fall Further
We're still a long way from the bottom of the housing crisis.
Chart courtesy of GMO LLC
The only question is whether we the fall will be quick, or gradual, or somewhere in between.
An analysis by money management firm GMO shows that we are still 17% above fair value, as of the end of Q2. But if prices stopped falling and held steady for 4 years or so, incomes may rise enough to reach fair value.
The bad news is that when a speculative bubble bursts, prices normally fall well below fair value before beginning to recover.
The preliminary existing home sales report showed that inventory dropped slightly in August but is still terribly high. The drop may be due to seasonal factors as relocating families get settled before the start of school.
Chart courtesy of GMO LLC
The only question is whether we the fall will be quick, or gradual, or somewhere in between.
An analysis by money management firm GMO shows that we are still 17% above fair value, as of the end of Q2. But if prices stopped falling and held steady for 4 years or so, incomes may rise enough to reach fair value.
The bad news is that when a speculative bubble bursts, prices normally fall well below fair value before beginning to recover.
The preliminary existing home sales report showed that inventory dropped slightly in August but is still terribly high. The drop may be due to seasonal factors as relocating families get settled before the start of school.
Source:
Jeremy Grantham. Meltdown! The Global Competence Crisis.
GMO Quarterly Letter. July 2008.
---
© 2008 Michael Cale
September 22, 2008
Las Vegas Real Estate Prices
Residential home prices are 15% to 35%+ lower than they were a year ago in much of Las Vegas.
This is based on price per square foot.
Chart courtesy of Las Vegas Sun
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This is based on price per square foot.
Chart courtesy of Las Vegas Sun
---
Source:
Alex Richards. Drop in median price paid per square foot
Las Vegas Sun. September 22, 2008.
http://www.lasvegassun.com/news/2008/sep/22/drop-median-price-paid-square-foot/
© 2008 Michael Cale
September 21, 2008
Who Exactly Are We Bailing Out?
In yet another weekend in the government's Bailout Mania, an enormous question is missing from the discussion.
Who exactly are we bailing out?
Who is being bailed out is not exactly clear, but there are pieces of information. Clearly the Wall Street banks that overleveraged themselves to the point of insolvency are getting some relief from their own idiocy, whether they deserve it is another issue.
Foreign central banks, especially China, are large holders of Fannie and Freddie bonds. Their investments are now secure, thanks to the largesse of the U.S. Treasury Department.
But the Feds are hyper-sensitive to counterparty risk. Bear Stearns and AIG were not bailed out because they were too big to fail. They were bailed out because they were to interconnected to fail.
Lehman Brothers, it seems, failed the interconnectivity test and was allowed to disappear.
But who exactly are these mysterious conterparties whose poor investments will be repaid with U.S. taxpayer money?
In today's New York Times, Gretchen Morgenson offers a clue.
Who exactly are we bailing out?
Who is being bailed out is not exactly clear, but there are pieces of information. Clearly the Wall Street banks that overleveraged themselves to the point of insolvency are getting some relief from their own idiocy, whether they deserve it is another issue.
Foreign central banks, especially China, are large holders of Fannie and Freddie bonds. Their investments are now secure, thanks to the largesse of the U.S. Treasury Department.
But the Feds are hyper-sensitive to counterparty risk. Bear Stearns and AIG were not bailed out because they were too big to fail. They were bailed out because they were to interconnected to fail.
Lehman Brothers, it seems, failed the interconnectivity test and was allowed to disappear.
But who exactly are these mysterious conterparties whose poor investments will be repaid with U.S. taxpayer money?
In today's New York Times, Gretchen Morgenson offers a clue.
A.I.G.’s financial statements provided a clue to the identities of some of its credit default swap counterparties. The company said that almost three-quarters of the $441 billion it had written on soured mortgage securities was bought by European banks. The banks bought the insurance to reduce the amounts of capital they were required by regulators to set aside to cover future losses.
Enjoy the absurdity: Billions in unregulated derivatives that were about to take down the insurance company that sold them were bought by banks to get around their regulatory capital requirements intended to rein in risk.1
Treasury Secretary Paulson has this morning advocated that foreign banks should also be eligible for the new $700 billion bailout. Originally, the proposal was limited to U.S. banks.
Some members of Congress are suggesting that home-owners facing foreclosure should also receive some sort of relief their own at the bailout trough.
Yes, enjoy the absurdity.
---
So it seems that the list of the bailout-worthy are home-buyers that speculated on real estate with their own home, Wall Street investment banks and insurance companies that speculated in derivatives, and foreign bankers that speculated in derivatives in a foreign country (the U.S.).
There will be a feeding frenzy in Congress over spending this much money. The list of the bailout-worthy will only grow.
Yes, enjoy the absurdity.
---
Source:
1. Gretchen Morgenson. Your Money at Work, Fixing Others’ Mistakes
New York Times. September 20, 2008.
http://www.nytimes.com/2008/09/21/business/21gret.html
2. Mike Allen. Exclusive: Foreign banks may get help.
Politico.com. September 21, 2008.
http://www.politico.com/news/stories/0908/13690.html
© 2008 Michael Cale
September 20, 2008
Friday Bank Death Watch
This Friday we mark the failure of Ameribank of Northfork, WV.
Ameribank had assets of $115 million and deposits of $102 million. It is the 12th bank failure this year, not counting the Wall Street investment banks or Fannie/Freddie.
The cost to the Deposit Insurance Fund is expected to be $42 million.
Source:
1. FDIC. PR-08082
Press Release. September 19, 2008.
http://www.fdic.gov/news/news/press/2008/pr08082.html
© 2008 Michael Cale
September 17, 2008
Money Markets Break the Buck
It's time to head to the bank to put savings in an FDIC-insured account.
Money market funds are having trouble maintaining their target share value of $1. This means money you thought was safe may not be so safe after all.
This is violating sacred territory for money managers.
A further sign of panic is that gold spiked by over 10% in one day.
Money market funds are having trouble maintaining their target share value of $1. This means money you thought was safe may not be so safe after all.
This is violating sacred territory for money managers.
A further sign of panic is that gold spiked by over 10% in one day.
Source:
1. Randall Forsyth. Not Even Money Funds are Safe
Barron's. September 16, 2008.
http://online.barrons.com/article/SB122160459019445225.html?mod=googlenews_barrons
© 2008 Michael Cale
$4 Trillion and Counting
A juicy graphic from the NYT on the losses in the financial sector.
Since October of last year, the stock market has lost $4 trillion. Poof... gone.
Over 20% of that has been in the banking sector.
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Since October of last year, the stock market has lost $4 trillion. Poof... gone.
Over 20% of that has been in the banking sector.
---
© 2008 Michael Cale
September 15, 2008
Lehman Brothers To File Bankruptcy
Well, we almost had a weekend without a bank failure.
Chart courtesy of: Stockcharts.com
September 12, 2008
Friday Bank Death Watch
No bank failures this week.
Well, only if you don't count Freddie, Fannie, and Lehman.
A Bailout for Lehman? Not Likely -- Business Week
Wall St falls amid Lehman, AIG worries -- Reuters
Lehman In For A Long Weekend -- Forbes
Why Hasn’t Lehman Come Calling on Fed’s Discount Window?
-- Wall Street Journal Blogs
Paulson Adamant No Money for Lehman, Fed Against It -- Bloomberg
From the Bloomberg article -
"It is about time'' the government stop providing assistance, said Allan Meltzer, an economist at Carnegie Mellon University in Pittsburgh and author of a history of the Fed. ``The system can't work if the bankers make the money and the taxpayers take the losses. That is just not viable.''If only Paulson would have had that realization a week ago, before the bailout of Fraudie and Phoney, the taxpayers would be much better off.
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© 2008 Michael Cale
The Garden of the Financial Forking Path
Here's the situation - your nephew has gotten himself deep into debt to a foreign loan shark and needs help. He owes $5,000 that he doesn't have. He gambles on a sure thing, only the sure thing wasn't. Being the kind uncle, you agree to let him off the hook and take on the $5,000 debt.
You give him $100 and tell him you will pay the rest later.
The problem - the kind uncle is you, and me, and every other American taxpayer; and the numbers above are actually in billions of dollars; and we already have our own debt problem that we can't pay.
It's has nearly been six months since the Fed first bailed out Bear Stearns in an effort to calm the markets and to restore confidence in the financial sector.
It didn't. The jig is up. Everyone knows that we're facing another fractional-reserve banking crisis. They have been a regular event throughout U.S. history. And this one is a big one.
The overarching problem of the nation is a simple one. There is too much debt. Too much mortgage debt, too much consumer debt, too much corporate debt, too much government debt. And thanks to opaque accounting rules, no one quite knows for sure who owes what to whom.
The plan to bail out FNM and FRE is going to add more debt to the already insolvent U.S. government.
[ As a side note: if an insolvent bank takes over a smaller insolvent bank, would that make them solvent? Answer: No. ]
The solution to this predicament is inevitable: the level of debt must come down. We are currently witnessing an incredible destruction of wealth.
After the announcement of the Fannie/Freddie bailout the cost of insuring U.S Treasury bonds against default jumped 3 basis points (b.p.) to a record high. That 20% increase (from 15 b.p. to 18 b.p.) generates an additional $2.88 billion per year in interest payments on the $9.6 trillion national debt.1
The federal government has been in the garden of the forking path. The government can do little, and let those who made foolish decisions by lending money to risky borrowers (and those who invested in the fools) suffer a severe, painful, but relatively brief downturn, possibly even a depression.
This path would be a disaster for the banking industry and those that invested in it. Equity shareholders would lose enormous sums of money. Large financial institutions, hedge funds, wealthy individuals, and foreign central banks, especially China's, would take large losses.
But U.S. banks that did not make those bad investments would survive and thrive and fill the void left by the collapse of their larger, unwise competitors.
The government has not chosen that path.
This does not mean that the losses will not be taken. They will.
You give him $100 and tell him you will pay the rest later.
The problem - the kind uncle is you, and me, and every other American taxpayer; and the numbers above are actually in billions of dollars; and we already have our own debt problem that we can't pay.
It's has nearly been six months since the Fed first bailed out Bear Stearns in an effort to calm the markets and to restore confidence in the financial sector.
It didn't. The jig is up. Everyone knows that we're facing another fractional-reserve banking crisis. They have been a regular event throughout U.S. history. And this one is a big one.
The overarching problem of the nation is a simple one. There is too much debt. Too much mortgage debt, too much consumer debt, too much corporate debt, too much government debt. And thanks to opaque accounting rules, no one quite knows for sure who owes what to whom.
The plan to bail out FNM and FRE is going to add more debt to the already insolvent U.S. government.
[ As a side note: if an insolvent bank takes over a smaller insolvent bank, would that make them solvent? Answer: No. ]
The solution to this predicament is inevitable: the level of debt must come down. We are currently witnessing an incredible destruction of wealth.
After the announcement of the Fannie/Freddie bailout the cost of insuring U.S Treasury bonds against default jumped 3 basis points (b.p.) to a record high. That 20% increase (from 15 b.p. to 18 b.p.) generates an additional $2.88 billion per year in interest payments on the $9.6 trillion national debt.1
The federal government has been in the garden of the forking path. The government can do little, and let those who made foolish decisions by lending money to risky borrowers (and those who invested in the fools) suffer a severe, painful, but relatively brief downturn, possibly even a depression.
This path would be a disaster for the banking industry and those that invested in it. Equity shareholders would lose enormous sums of money. Large financial institutions, hedge funds, wealthy individuals, and foreign central banks, especially China's, would take large losses.
But U.S. banks that did not make those bad investments would survive and thrive and fill the void left by the collapse of their larger, unwise competitors.
The government has not chosen that path.
This does not mean that the losses will not be taken. They will.
Instead, the U.S. government will tax its citizens to pay for most of the losses of the bankers and the speculators since their risky investments have performed poorly.
The government has two options to pay for these losses.
The government has two options to pay for these losses.
It can raise taxes. This may be difficult, both politically and financially. The government will likely raise taxes to pay for the bankrupt Social Security trust fund, and the bankrupt government-run health care system (Medicare), a few foreign wars, and possibly for a bankrupt highway trust fund.
The second option to pay for the banker's losses is that the government can take the Mugabe approach and essentially just print the money. That way, everyone who has an paycheck in dollars will pay for it through lost purchasing power. And this kind of inflation often brings more inflation. Ask anyone in Zimbabwe.
Because the government is fighting this inevitable adjustment, it will not be quick and severe. It will be long and torturous.
Thanks to the action of kind Uncle Paulson, the loan sharks are going to get their money. And the U.S. government is going to be the enforcer. Your nephew, Big Money, is appreciative, but don't go asking for a handout, at least without being willing to pay a stiff interest rate.
The second option to pay for the banker's losses is that the government can take the Mugabe approach and essentially just print the money. That way, everyone who has an paycheck in dollars will pay for it through lost purchasing power. And this kind of inflation often brings more inflation. Ask anyone in Zimbabwe.
Because the government is fighting this inevitable adjustment, it will not be quick and severe. It will be long and torturous.
Thanks to the action of kind Uncle Paulson, the loan sharks are going to get their money. And the U.S. government is going to be the enforcer. Your nephew, Big Money, is appreciative, but don't go asking for a handout, at least without being willing to pay a stiff interest rate.
Sources:
1. Randall Forsyth. CBO, CDS Mart Agree With Sarah on Fan and Fred.
Barron's. September 10, 2008.
http://online.barrons.com/article/SB122103951233818965.html?mod=9_0002_b_online_exclusives_weekday_r1
© 2008 Michael Cale
September 9, 2008
Stick Math on the Deposit Insurance Fund
The FDIC's Deposit Insurance Fund (DIF) is in sad shape.
At the end of Q1, the fund had $52.8 billion in reserves. So far this year, the bank failures that have taken place in Q2 and Q3 will cost the fund almost $8 billion, based on FDIC estimates.
Last year the fund took in $2.2 billion in insurance premiums paid by banks. The FDIC has already asked Congress to increase these premiums.
Assuming the current burn rate of $8 billion per year and just over $2 billion in revenue, the fund would be entirely depleted in eight years, in 2016.
An increasing rate of bank failure would hasten the fund's demise (and a likely government bailout). A significant increase in premiums paid into the fund would postpone the DIF depletion.
© 2008 Michael Cale
September 8, 2008
Another Weekend, Another Bailout
In another example of crony socialism, the weekend brought the announcement that the Federal Reserve and the Treasury are taking over Freddie Mac and Fannie Mae.
The managers of these companies have alternately manipulated earnings, overstated capital, and bent accounting rules to the breaking point. Unfortunately this happens in America on occasion. The executives of Enron went to jail. The executives at Freddie and Fannie will likely receive millions of dollars in their exit packages while taxpayers are stuck with paying for their bad decisions.
This bailout will accomplish little to alleviate the ongoing credit crisis.
The combination of too-low interest rates and allowing banks to keep loans off their balance sheets created too much debt. The debt level grew to such an enormous level that the credit markets collapsed.
The credit collapse thus far has been completely reflected the unwinding of the most pronounced asset bubble in modern history. The negative credit dynamics that always ensue following a consumer recession have yet to be felt but are coming down the pike. While it is true that total residential mortgage debt is over $10 trillion, keep in mind that outstanding non-mortgage consumer loans are also huge at $2.5 trillion and commercial real estate credit outstanding comes to another $2.5 trillion; and then we have to add on another $6 1/2 trillion of leverage in the nonfinancial corporate sector. The mortgage market is obviously very big, it grabs everybody's attention, but it still comprises less than one-third of total outstanding private sector debt in this country. The volume of outstanding household and business debt, in the aggregate, expanded so exponentially during the bubble that it now represents an unprecedented 350% of private sector GDP compared to 250% when the last leg of the 20-year secular credit expansion turned parabolic from 2001 to 2007.1
The debt level must come down. It will. It will take years.
---
Source
1. David Rosenberg. Bringing Out the "Bazooka"
Merrill Lynch. September 7, 2008.
https://www.gpcresearch.ml.wallst.com//common/emaillink/pdf.asp?SSS_E4AB50566FE737E92036E71A43BE8DA9&pdf=pdf/Bringing_Out_the_quot_Bazooka_.pdf
© 2008 Michael Cale
September 7, 2008
Bear Market Making Stocks More Expensive
An article in today's New York Times details that stocks are getting more expensive, despite the bear market.
Historically, bull markets emerge from bear markets after stocks sink to attractive levels for investors. Since 1938, the average P/E for the S.& P. 500 at the start of new bull markets has been 13, according to Standard & Poor’s Equity Research. That’s considerably lower than the current level of 24.
Though share prices are off by about 20 percent since the market peaked on Oct. 9, 2007, corporate earnings —the “E” in the P/E ratio — have fallen even further. In the first quarter this year, earnings of the S.& P. 500 sank 17.5 percent, according to Thomson Financial. But the index, excluding dividends, itself declined 9.9 percent. And in the second quarter, corporate profits declined by an estimated 22 percent while stock prices fell by a much more modest 3.2 percent.1
A similar move in the P/E ratio occurred when stocks prices fell in 2000-2002.
Source:
1. Paul Lim. Why the Bear Is Alive and Well
New York Times. September 7, 2008.
http://www.nytimes.com/2008/09/07/business/yourmoney/07fund.html?ref=business
© 2008 Michael Cale
September 6, 2008
Florida Weekend
The beaches of Southwest Florida are largely deserted this weekend. The summer is over and it is the peak of hurricane season.
It's a great time to enjoy the sun and surf. As long as the storms don't head your way.
So far, so good.
© 2008 Michael Cale
R. C. Otter's Island Eats
Dinner at R.C. Otter's on Captiva Island is a treat. Live music and fantastic service - Kyle is simply the best waiter, possibly ever.
The seafood quesadillas were a fantastic surprise. I normally steer clear of so much clutter (cheese, salsa, etc.) with my seafood. But the seafood quesadilla was excellent.
A mix of shrimp, fish, and crab meat, sweet onions, bell peppers, and cheese, tucked into a crispy flour tortilla. Delicious.
I recommend the outdoor seating if the weather is favorable. Plus, you can have your meal served with a can of bug spray, just in case you need it.
---
© 2008 Michael Cale
Friday Bank Death Watch
Another Friday, another bank failure.
This week it is Silver State Bank in Henderson, NV. Henderson is just Southeast of Las Vegas.
Silver State Bank had assets of $2 billion at the time of closure.
This is the 11th bank to fail this year and the second Nevada bank.
This closure is expected to cost the FDIC insurance fund between $450 million and $550 million.
FDIC. Nevada State Bank Acquires the Insured Deposits of Silver State Bank, Henderson, Nevada
Press Release. September 5, 2008.
http://www.fdic.gov/news/news/press/2008/pr08077.html
© 2008 Michael Cale
September 5, 2008
Threading The Needle
Traveling to SW Florida for a long weekend so some travel postings will follow.
Tropical Storm Hanna should be clear. But Hurricane Ike could be a factor on Tuesday's return trip.
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