The combination of massive fiscal stimulus and a monetary policy set to "full flood" did a lot of the heavy lifting but the real kicker was a flood of "hot money" driven by a carry trade by investment banks flush with bailout money looking for a yield differential and currency gains as the pound and buck dive. The Ruddster bought some time but it will end badly, imo.
Keen notes...
2010 will be a bad year for the Australian economy:
The combination of the RBA’s rate rises and the ending of the First Home Buyers Boost will in all likelihood prick the house price bubble inspired by the Boost in the first place—and lead as many as 175,000 households to be very angry that they were enticed into this speculative bubble in the first place. If this happens, there is little prospect of making the House Price Souffle rise twice by yet another foolish enticement into debt.
The political pressure on the government may lead it to unwind its stimulus, which will remove a key prop from the economy; and
Deleveraging, which has been the looming problem that government policy (especially the First Home Vendors Grant) has simply delayed, will kick in as it has in the USA. The most likely manifestation would be a decline in discretionary consumption and non-mining investment.
I therefore expect that the RBA won’t get to complete its intended program of raising interest rates, but will be forced to go into reverse in 2010 as it was in 2008. It shouldn’t be forgotten that the RBA was still raising rates in mid-2008 to fight inflation. They didn’t see the GFC coming, and I believe that they’re making a similar mistake this time—believing that it’s all behind us when the special factors that minimised the impact are terminating.
So no I don’t believe we have dodged the iceberg—we’ve merely pushed it below the surface, from where it will rise again to dent out economic hull once more. And all the while the neoclassical economists who didn’t realise they were in an ice field in the first place are busily rearranging the deckchairs on the Titanic.
http://www.debtdeflation.com/blogs/2009/11/02/debtwatch-no-40-november-2009-have-we-dodged-the-iceberg/
Showing posts with label real estate. Show all posts
Showing posts with label real estate. Show all posts
3 November 2009
16 May 2009
Commercial real estate to drop dead next
Realpoint LLC has a chart showing commercial real estate defaults assesed by when the mortgages were originated. Much like the Markit charts for subprime. The most recent sour fast, but so do the older ones.
More here
21 January 2009
Ghost Malls Will Be Appearing
Commercial real estate, next shoe to drop....
James Quinn
January 19th 2009
America’s economy supports more than 1.1 million retail stores. There are approximately 1,100 Malls in the United States, not counting the thousands of strip mall centers. That will soon change as once thriving malls become ghost malls. By 2011, America’s malls within two years will have an entirely different set of numbers.
International Council of Shopping Centers (ICSC) chief economist Michael Niemira tries to put a good face on the gloom. He says, “In the midst of all this doom and gloom, it’s hard to imagine it getting better… But keep in mind, what happens in strong downturns is there’s a hefty pent-up demand. It’s wrong to extrapolate these conditions for the next year or two.”
But Mr. Niemira is probably wrong. There is no pent-up demand. Americans have bought everything they’ve desired for the last twenty years. The over-spending and over-leverage will take a decade to unwind.
According to the ICSC, about 150,000 stores are anticipated to shut down in 2009, in addition to the 150,000 that closed in 2008 and 135,000 in 2007. Normally, 110,000 to 125,000 new stores open per year. At least 700,000 of retail jobs will be lost. The opening of new stores will grind to a halt in 2009.
Some major retailers that have closed or will close include: Circuit City -728 stores; Linens N Things - 500 stores; Bombay Company- 384 stores; Sharper Image-184 stores; Foot Locker -140; Pacific Sunwear - 153. Other large retailers are closing underperforming stores and scaling back expansions plans. By 2011, at least 15% of the existing retail base will have gone to retail heaven. With the amount of vacant stores likely to be in excess of 200,000, there will be no need for the construction of new locations for many years.
Most of the retailers that are closing lease their locations from mall developers such as General Growth Properties, Simon Properties, Mills Corp., Pennsylvania REIT, and Vornado Realty Trust. These developers have a quadruple whammy hitting them in 2009. Many borrowed heavily to finance massive mall expansion. These loans were generally for five to seven year terms. The Wall Street wiz kids and their Collaterized Debt Obligation (CDO) machine generated the vast majority of financing in the last half decade.
According to commercial real estate expert Andy Miller, the collapse will come more rapidly than the residential collapse. “By contrast,” he says, “in the commercial world, the properties are fewer and much bigger. For example, you may have ten properties in a commercial pool that ultimately works its way into CDOs. Those loans are huge. You may have a shopping center loan in there for $25 million and an office building loan for $30 million dollars. As a result, if you have a default on just one of those loans, you can effectually wipe out all of the subordinate tranches.
Miller adds, “And that is why when you see the problems begin to appear on the commercial front. It’s going to be a much quicker sort of devolution than we saw on the residential side. In the commercial world, most of the financing that happened outside of the apartment business was done by conduits, and there are no more conduits left, and conduits were doing the stupidest loans you could find. They were doing an advertised 80 percent loan-to-value, which was usually more closely aligned to a 100 percent loan-to-value. They were dealing with no coverage. They were all non-recourse loans. Many of them were interest-only loans. Those loans are now gone. You can’t refinance them, and if you could, the terms would be onerous.”
The meltdown of materialism has hit the malls. For the last twenty years the American consumer has carried the weight of the world on its shoulders. This has been a heavy burden, but with consumers on steroids, it didn’t seem so heavy. The steroid of choice for the American consumer has been debt. They have utilized home equity loans, cash out refinancing, credit card debt, and auto loans to live far above their means. It has been a wild ride, but the ride is over. They can’t get steroids from their dealers (banks) anymore. The pseudo-wealth that has been created in the last twenty years has begun to unwind, but the deceleration will increase in 2009.
Average Americans, who saw their paper wealth growing rapidly as their home values increased, took advantage of this by refinancing their mortgages and extracting the equity from their homes and spending it. They sucked $3 trillion of equity out of their houses. Major Banks offered credit cards using your home equity as a way to pay everyday expenses like groceries, gas and clothes. Eating your house was never so easy. The massive number of excess home sales and equity withdrawal led to huge demand for home furnishings, remodeling services, appliances, electronic gadgets, BMWs, and exotic vacations. This led to massive expansion by retail and restaurant chains based on extrapolation of this demand. Enter mall mania.
But a psychological change has occurred in American consumers. They have lost $30 trillion in value from their homes and investments in the last two years. No amount of fiscal stimulation will reverse this psychological trauma. The savings rate will go from 0 percent to 8 percent. Mike Shedlock of Sitka Pacific Capital Management recently described the situation. “Peak credit has been reached. That final wave of consumer recklessness created the exact conditions required for its own destruction. The housing bubble orgy was the last hurrah. It is not coming back and there will be no bigger bubble to replace it. Consumers and banks have both been burnt, and attitudes have changed.” Now the impact of a retrenching consumer will be felt far and wide. Consumer spending has accounted for 70 percent of GDP. It will revert to at least.the long term mean of 65 percent.
David Rosenberg, the brilliant economist from Merrill Lynch, describes what will happen next: “This is an epic event; we’re talking about the end of a 20-year secular credit expansion that went absolutely parabolic from 2001-2007.Before the US economy can truly begin to expand again, the savings rate must rise to pre-bubble levels of 8 percent, US housing stocks must fall to below eight months’ supply, and the household interest coverage ratio must fall from 14 percent to 10.5 percent. It’s important to note what sort of surgery this is going to require. We will probably have to eliminate $2 trillion of household debt to get there. This will happen either through debt being written off, as major financial institutions continue to do, or for consumers themselves to shrink their own balance sheets.”
Billions of debt needs to be refinanced, and there is no one willing to make those loans. The major mall developers are so worried they have made an all out press to get a piece of the TARP. As retailers go bankrupt, vacancy rates have reached 9.4 percent for shopping centers, according to CoStar Group. With virtually no demand, rental income is plunging. With cap rates eroding and operating expenses going up, a perfect storm will hit mall developers in 2009.
The negative feedback loop will accelerate as the year progresses and will likely spiral out of control by late 2009 and early 2010. The negative feedback loop will lead to developer bankruptcies and ultimately to Ghost Malls, particularly in the outer suburbs. The collapse of developers will result in more major write-offs by banks. This time, many smaller regional banks will feel the major pain. The U.S. taxpayer will need to step up to the plate and assume responsibility for their lack of spending.
Mall owners and commercial developers are on the brink of bankruptcy. Commercial developer CB Richard Ellis didn’t sound too optimistic in a recent 10Q filing. He stated, “We are highly leveraged and have significant debt service obligations. Although our management believes that the incurrence of long-term indebtedness has been important in the development of our business, including facilitating our acquisitions of Insignia and Trammell Crow Company, the cash flow necessary to service this debt is not available for other general corporate purposes, which may limit our flexibility in planning for, or reacting to, changes in our business and in the commercial real estate services industry. Notwithstanding the actions described above, however, our level of indebtedness and the operating and financial restrictions in our debt agreements both place constraints on the operation of our business.”
As Americans realize that they don’t “need” a $5 Starbucks latte, IKEA knickknacks, Jimmy Choo shoes, Rolex watches, granite counters, and stainless steel appliances, our mall-centric world will end. As low prices become the only factor that drives retail sales, retailers will have lower profits in the future, further restricting expansion and renovations.
General Growth Properties, a mall developer which owns or operates 200 malls, added $4 billion of debt in the last three years and is teetering on the brink of bankruptcy. Simon Properties, which owns or operates 320 malls, added $3 billion of debt in the last three years and will be greatly affected by the coming downturn. Many smaller developers will be in even dire straits. With shrinking cash flow, looming debt refinancing, and dim prospects for a resumption of conspicuous consumption, Mall developers are destined for a bleak future.
Every major retailer in the United States has built their expansion plans on an assumption that American consumers would continue to spend at an unsustainable rate. That crucial assumption error will lead to the bankruptcy of any retailer that financed their expansion with debt. Warren Buffet’s wisdom will be borne out, “Only when the tide goes out do you discover who’s been swimming naked.”
link
James Quinn
January 19th 2009
America’s economy supports more than 1.1 million retail stores. There are approximately 1,100 Malls in the United States, not counting the thousands of strip mall centers. That will soon change as once thriving malls become ghost malls. By 2011, America’s malls within two years will have an entirely different set of numbers.
International Council of Shopping Centers (ICSC) chief economist Michael Niemira tries to put a good face on the gloom. He says, “In the midst of all this doom and gloom, it’s hard to imagine it getting better… But keep in mind, what happens in strong downturns is there’s a hefty pent-up demand. It’s wrong to extrapolate these conditions for the next year or two.”
But Mr. Niemira is probably wrong. There is no pent-up demand. Americans have bought everything they’ve desired for the last twenty years. The over-spending and over-leverage will take a decade to unwind.
According to the ICSC, about 150,000 stores are anticipated to shut down in 2009, in addition to the 150,000 that closed in 2008 and 135,000 in 2007. Normally, 110,000 to 125,000 new stores open per year. At least 700,000 of retail jobs will be lost. The opening of new stores will grind to a halt in 2009.
Some major retailers that have closed or will close include: Circuit City -728 stores; Linens N Things - 500 stores; Bombay Company- 384 stores; Sharper Image-184 stores; Foot Locker -140; Pacific Sunwear - 153. Other large retailers are closing underperforming stores and scaling back expansions plans. By 2011, at least 15% of the existing retail base will have gone to retail heaven. With the amount of vacant stores likely to be in excess of 200,000, there will be no need for the construction of new locations for many years.
Most of the retailers that are closing lease their locations from mall developers such as General Growth Properties, Simon Properties, Mills Corp., Pennsylvania REIT, and Vornado Realty Trust. These developers have a quadruple whammy hitting them in 2009. Many borrowed heavily to finance massive mall expansion. These loans were generally for five to seven year terms. The Wall Street wiz kids and their Collaterized Debt Obligation (CDO) machine generated the vast majority of financing in the last half decade.
According to commercial real estate expert Andy Miller, the collapse will come more rapidly than the residential collapse. “By contrast,” he says, “in the commercial world, the properties are fewer and much bigger. For example, you may have ten properties in a commercial pool that ultimately works its way into CDOs. Those loans are huge. You may have a shopping center loan in there for $25 million and an office building loan for $30 million dollars. As a result, if you have a default on just one of those loans, you can effectually wipe out all of the subordinate tranches.
Miller adds, “And that is why when you see the problems begin to appear on the commercial front. It’s going to be a much quicker sort of devolution than we saw on the residential side. In the commercial world, most of the financing that happened outside of the apartment business was done by conduits, and there are no more conduits left, and conduits were doing the stupidest loans you could find. They were doing an advertised 80 percent loan-to-value, which was usually more closely aligned to a 100 percent loan-to-value. They were dealing with no coverage. They were all non-recourse loans. Many of them were interest-only loans. Those loans are now gone. You can’t refinance them, and if you could, the terms would be onerous.”
The meltdown of materialism has hit the malls. For the last twenty years the American consumer has carried the weight of the world on its shoulders. This has been a heavy burden, but with consumers on steroids, it didn’t seem so heavy. The steroid of choice for the American consumer has been debt. They have utilized home equity loans, cash out refinancing, credit card debt, and auto loans to live far above their means. It has been a wild ride, but the ride is over. They can’t get steroids from their dealers (banks) anymore. The pseudo-wealth that has been created in the last twenty years has begun to unwind, but the deceleration will increase in 2009.
Average Americans, who saw their paper wealth growing rapidly as their home values increased, took advantage of this by refinancing their mortgages and extracting the equity from their homes and spending it. They sucked $3 trillion of equity out of their houses. Major Banks offered credit cards using your home equity as a way to pay everyday expenses like groceries, gas and clothes. Eating your house was never so easy. The massive number of excess home sales and equity withdrawal led to huge demand for home furnishings, remodeling services, appliances, electronic gadgets, BMWs, and exotic vacations. This led to massive expansion by retail and restaurant chains based on extrapolation of this demand. Enter mall mania.
But a psychological change has occurred in American consumers. They have lost $30 trillion in value from their homes and investments in the last two years. No amount of fiscal stimulation will reverse this psychological trauma. The savings rate will go from 0 percent to 8 percent. Mike Shedlock of Sitka Pacific Capital Management recently described the situation. “Peak credit has been reached. That final wave of consumer recklessness created the exact conditions required for its own destruction. The housing bubble orgy was the last hurrah. It is not coming back and there will be no bigger bubble to replace it. Consumers and banks have both been burnt, and attitudes have changed.” Now the impact of a retrenching consumer will be felt far and wide. Consumer spending has accounted for 70 percent of GDP. It will revert to at least.the long term mean of 65 percent.
David Rosenberg, the brilliant economist from Merrill Lynch, describes what will happen next: “This is an epic event; we’re talking about the end of a 20-year secular credit expansion that went absolutely parabolic from 2001-2007.Before the US economy can truly begin to expand again, the savings rate must rise to pre-bubble levels of 8 percent, US housing stocks must fall to below eight months’ supply, and the household interest coverage ratio must fall from 14 percent to 10.5 percent. It’s important to note what sort of surgery this is going to require. We will probably have to eliminate $2 trillion of household debt to get there. This will happen either through debt being written off, as major financial institutions continue to do, or for consumers themselves to shrink their own balance sheets.”
Billions of debt needs to be refinanced, and there is no one willing to make those loans. The major mall developers are so worried they have made an all out press to get a piece of the TARP. As retailers go bankrupt, vacancy rates have reached 9.4 percent for shopping centers, according to CoStar Group. With virtually no demand, rental income is plunging. With cap rates eroding and operating expenses going up, a perfect storm will hit mall developers in 2009.
The negative feedback loop will accelerate as the year progresses and will likely spiral out of control by late 2009 and early 2010. The negative feedback loop will lead to developer bankruptcies and ultimately to Ghost Malls, particularly in the outer suburbs. The collapse of developers will result in more major write-offs by banks. This time, many smaller regional banks will feel the major pain. The U.S. taxpayer will need to step up to the plate and assume responsibility for their lack of spending.
Mall owners and commercial developers are on the brink of bankruptcy. Commercial developer CB Richard Ellis didn’t sound too optimistic in a recent 10Q filing. He stated, “We are highly leveraged and have significant debt service obligations. Although our management believes that the incurrence of long-term indebtedness has been important in the development of our business, including facilitating our acquisitions of Insignia and Trammell Crow Company, the cash flow necessary to service this debt is not available for other general corporate purposes, which may limit our flexibility in planning for, or reacting to, changes in our business and in the commercial real estate services industry. Notwithstanding the actions described above, however, our level of indebtedness and the operating and financial restrictions in our debt agreements both place constraints on the operation of our business.”
As Americans realize that they don’t “need” a $5 Starbucks latte, IKEA knickknacks, Jimmy Choo shoes, Rolex watches, granite counters, and stainless steel appliances, our mall-centric world will end. As low prices become the only factor that drives retail sales, retailers will have lower profits in the future, further restricting expansion and renovations.
General Growth Properties, a mall developer which owns or operates 200 malls, added $4 billion of debt in the last three years and is teetering on the brink of bankruptcy. Simon Properties, which owns or operates 320 malls, added $3 billion of debt in the last three years and will be greatly affected by the coming downturn. Many smaller developers will be in even dire straits. With shrinking cash flow, looming debt refinancing, and dim prospects for a resumption of conspicuous consumption, Mall developers are destined for a bleak future.
Every major retailer in the United States has built their expansion plans on an assumption that American consumers would continue to spend at an unsustainable rate. That crucial assumption error will lead to the bankruptcy of any retailer that financed their expansion with debt. Warren Buffet’s wisdom will be borne out, “Only when the tide goes out do you discover who’s been swimming naked.”
link
12 October 2008
How to Ruin the U.S. Economy
by Ben Stein
Posted on Monday, October 6, 2008, 12:00AM
http://finance.yahoo.com/print/expert/article/yourlife/112984
1) Have a fiscal policy that creates immense deficits in good times and bad, burdening America's posterity with staggering burdens of repaying the debt.
2) Eliminate regulation of Wall Street and/or fail to enforce the regulations that already exist, instead trusting Wall Street and other money managers and speculators to manage other people's money with few or no regulations and little oversight.
3) Have an energy policy that disallows producing our own energy and instead requires that we buy energy from abroad, thus making our oil prices highly volatile and creating large balance of payments deficits, lowering the value of the dollar and thus making the problem get progressively worse.
4) Have Congress mandate that banks and other financial entities lend money to persons they know in advance to have poor credit ratings or none at all.
5) Allow investment banks, insurers, and banks to bet their entire net worth and then some on the premise that borrowers known to be improvident will in fact repay those loans.
6) Allow the creation of large betting pools called "hedge funds" that can move markets and control the outcome of trading, thus taking a forum for savings and retirement for families and making it into a rigged casino game that exists primarily to fleece suckers like ordinary working men and women.
7) Have laws that protect corporate officers from being sued for misconduct but at the same time punish lawyers in the private sector who ferret out such misconduct and try to make accountable the people responsible for shareholder and investor losses. If one of those lawyers gets particularly aggressive in protecting stockholders, put him in prison.
8) Appoint as head of the United States Treasury Department a man whose whole life was spent on Wall Street, who became fantastically rich through his peddling of junk bonds at his firm while the firm later sold short those same sorts of bonds.
9) Scare Americans into putting up $750 billion of their hard earned money to bail out the billionaires and their friends who created the market for loans to poor credit risks (The "subprime" market) and the unbelievably large side bets on those loans, promising that such a bailout would save the retirement savings of Americans, then allow the immense hedge funds to make the market crater immediately afterwards.
10) Propose to save the situation by surtaxing the oil industry, which is owned by our fellow Americans, mostly in their retirement plans, thus penalizing Americans for investing in companies that efficiently and legally produce an indispensable product.
11) Insist that the free market requires that banks and insurers with friends of the Secretary of the Treasury be saved but allow other entities not so fortunate to fail, thus creating total uncertainty and terror among financial institutions, and demolishing all of the confidence built up in financial circles since the days of FDR.
12) Then have the Republican candidate say he would keep on the job the Treasury Secretary who facilitated the crisis, failed to protect the nation from the crisis, got the taxpayers to pony up to save his Wall Street buddies, and have the Democratic candidate, as noted, say he would save the day by taxing the stockholders of energy companies.
There, that should do it.
Posted on Monday, October 6, 2008, 12:00AM
http://finance.yahoo.com/print/expert/article/yourlife/112984
1) Have a fiscal policy that creates immense deficits in good times and bad, burdening America's posterity with staggering burdens of repaying the debt.
2) Eliminate regulation of Wall Street and/or fail to enforce the regulations that already exist, instead trusting Wall Street and other money managers and speculators to manage other people's money with few or no regulations and little oversight.
3) Have an energy policy that disallows producing our own energy and instead requires that we buy energy from abroad, thus making our oil prices highly volatile and creating large balance of payments deficits, lowering the value of the dollar and thus making the problem get progressively worse.
4) Have Congress mandate that banks and other financial entities lend money to persons they know in advance to have poor credit ratings or none at all.
5) Allow investment banks, insurers, and banks to bet their entire net worth and then some on the premise that borrowers known to be improvident will in fact repay those loans.
6) Allow the creation of large betting pools called "hedge funds" that can move markets and control the outcome of trading, thus taking a forum for savings and retirement for families and making it into a rigged casino game that exists primarily to fleece suckers like ordinary working men and women.
7) Have laws that protect corporate officers from being sued for misconduct but at the same time punish lawyers in the private sector who ferret out such misconduct and try to make accountable the people responsible for shareholder and investor losses. If one of those lawyers gets particularly aggressive in protecting stockholders, put him in prison.
8) Appoint as head of the United States Treasury Department a man whose whole life was spent on Wall Street, who became fantastically rich through his peddling of junk bonds at his firm while the firm later sold short those same sorts of bonds.
9) Scare Americans into putting up $750 billion of their hard earned money to bail out the billionaires and their friends who created the market for loans to poor credit risks (The "subprime" market) and the unbelievably large side bets on those loans, promising that such a bailout would save the retirement savings of Americans, then allow the immense hedge funds to make the market crater immediately afterwards.
10) Propose to save the situation by surtaxing the oil industry, which is owned by our fellow Americans, mostly in their retirement plans, thus penalizing Americans for investing in companies that efficiently and legally produce an indispensable product.
11) Insist that the free market requires that banks and insurers with friends of the Secretary of the Treasury be saved but allow other entities not so fortunate to fail, thus creating total uncertainty and terror among financial institutions, and demolishing all of the confidence built up in financial circles since the days of FDR.
12) Then have the Republican candidate say he would keep on the job the Treasury Secretary who facilitated the crisis, failed to protect the nation from the crisis, got the taxpayers to pony up to save his Wall Street buddies, and have the Democratic candidate, as noted, say he would save the day by taxing the stockholders of energy companies.
There, that should do it.
22 July 2008
The Failure of the American Financial System
"Where are the leaders? Has our political process become so compromised by powerful interest groups and the threat of character assassination that even the best among us will not dare to speak honestly about the solutions that might bring us back to common sense and fundamental fairness?" Senator Jim Webb, A Time to Fight
One of the reasons we like Noriel Roubini is that he is an economist willing to dig into pertinent details, to get involved with current events, to take an intellectual stand and defend it, to tell it like it is, to borrow a phrase from another era.
This places him as a man apart from many of his economic peers, who lurk in obscure and largely irrelevant details, hiding behind rhetorical flourishes and courtly manners, lurking in the waiting rooms of universities and thinktanks, emerging every so often to speak for some vested interest with studies supporting pre-ordained conclusions. All of which of course is absolutely useless if not harmful to the real economy and legitimate achievement. But it does leave them open for research grants, and appointments, honorariums, and self-advancement within a corrupted system that rewards those who propagate it with the motto, go along to get along.
There is a management style in which achievement is rarely considered, although there is often an intricate if not baroque system of measures amenable to manipulation, but mistakes are penalized, and heavily. As one manager of a large business said in an interview, "If you do 99 things right, and one thing wrong, all they will remember is what you have done wrong and use it against you, depending on who you are."
And the shame is, he was right. The firm for which he worked had ceased to be a meritocracy, and instead had become an oligopoly in which influence-peddling and personal connections mattered above all, even as the business results deteriorated. Its vision and preoccupations turned increasingly inward on itself, almost obsessively. It eventually went bankrupt, formally, long after it had become functionally bankrupt. We saw this phenomenon at any number of mature companies we visited in the course of our consultancy.
Yes, there is that element of oligarchy in all societies, in all companies, in every organization, especially after they mature after a long period of relative stability, and unfortunately fall under the control of a few powerful people whose number one priority is self-perpetuation.
It is a matter of degree. When that modus operandi becomes predominant, pervasive, you have an organization that will surely soon be in trouble, and is headed towards a serious change of management, a major shakeup, a sometimes spectacular and precipitous failure, if it is subject to the forces of the markets.
So too it is with countries. This is what had happened to the former Soviet Union. And it is now happening to The United States and its financially-heavy economy. We have a bad case of the winner's curse. The dollar as the world's reserve currency fostered a deterioration of the American spirit that acted like slow poison on the vigor of the real economy.
The US is going to be passing through a purging of the system and its management for some time, measured in years but not decades, until it emerges again and can move forward.
The Coming Systemic Bust of the U.S. Banking System: “Dead Stocks Rallying”
Nouriel Roubini
Jul 20, 2008
RGE Monitor
This past week started with concerns about another systemic meltdown of the U.S. financial system as the insolvency of Fannie and Freddie was revealed and as IndyMac went bust (this third largest bank collapse in U.S. history). But the week ended with a remarkable rally of financial stocks as better than expected results from Wells Fargo, JP Morgan and Citi soothed the fears that major financial institutions were in even more distress than already predicted by market analysts.
Unfortunately, this massive rally of financial stocks in the latter part of the week is just another temporary bear market rally that will fizzle away once the onslaught of bad financial and macro news builds up again.
The views I presented in a recent blog that we will experience a severe financial and banking crisis received the support of many well respected commentators. Alan Abelson – at Barron’s – is one of the most senior and well known commentators on financial issues and on Wall Street. In his latest Barron’s column – aptly titled “Dead Stocks Rallying” he wrote:
WHY WE'RE STILL BEARISH WAS SPELLED out starkly in a dispatch we received last week from Nouriel Roubini. Nouriel is a professor of economics at NYU Stern School of Business (but don't hold that against him) and runs an economic
advisory firm called RGE Monitor that casts a knowing and clear eye on the
global financial and economic scene. We think he's top-notch (which means we
agree with him, a lot of the time).
The nub of his argument is that we're suffering the worst financial crisis since the Great Depression, and he proceeds to give chilling chapter and verse. He predicts that hundreds of small banks loaded with real estate will go bust and dozens of large regional and national banks will also find themselves in deep do-do.
He reckons that, in a few years, there'll be no major independent broker-dealers left: They'll either pack it in or merge, victims of excessive leverage and a badly flawed and discredited business model.
The Federal Deposit Insurance Corp., after it gets through picking up the pieces of IndyMac, will sooner or later have to get a capital transfusion, Nouriel asserts, because its insurance premiums won't cover the tab of rescuing all the troubled banks. He foresees credit losses ultimately reaching at least $1 trillion and anticipates a heap of woe for credit purveyors across the board.
The poor consumer, he contends, is shopped out and being hammered by falling home prices, falling equity prices, falling jobs and incomes, rising inflation. The recession he anticipates will last 12 to 18 months. And the rest of the world won't escape: He looks for hard landings for 12 major economies. As for the stock market, he hazards that there's plenty of room left on the downside. In fact, he feels the bear market won't end until equities are down a full 40% from their peaks.
We must say this vision is a mite too apocalyptic even for us. But Nouriel is not a
professional fear-monger out to make a splash with end-of-the-world
prognostications He's a sound guy with a solid record and an impressive résumé.
We obviously believe his views are worth pondering, even if they ruin your
appetite.
That was a very nice summary by Abelson of my views and a kind endorsement of them.
But how to square the views that a large fraction of the US financial system is in trouble with the apparently better than expected earnings results and lower than expected writedowns presented by financial institutions such as Wells Fargo, JP Morgan and Citi that led to the financials’ stocks most recent rally? There are many reasons why those earnings results are misleading and cosmetically retouched upward while the true financial conditions of the financial system are more dire than otherwise presented.
Let us discuss next in some detail the various reasons why financial conditions of financial firms and banks are much worse than those headline figures and why we the US will experience a systemic financial crisis…
First of all, in a week when only a massive and open ended bailout rescued Fannie and Freddie, when IndyMac went bust and when Merrill presented much worse than expected results it is very hard to be optimistic about the health of the US financial institutions. Reports in the next few days will reveal whether reality is closer to Fannie/Freddie/IndyMac/Merrill or rather closer to the Citi/JPMorgan/Wells Fargo outlook.
Most financial institutions are putting increasing numbers of assets in the illiquid buckets of Level 2 and Level 3 assets. While FASB 157 should prevent manipulation of the valuation of such illiquid assets, forbearance by the SEC, the Fed and other regulators allows a massive amount of fudging.
An insider told me that in a major financial institution the approach is as follows now: top management decide in advance what the announced writedowns should be and folks dealing with the toxic/illiquid assets come up with totally ad hoc assumptions to make sure that such illiquid assets are valued consistently with the decided-in-advance amount of writedowns and losses.
This is not earnings smoothing; this is active manipulation and falsification of financial results aimed at creating even more obfuscation of the true state of financial institutions. This obfuscation is actively abetted by the SEC, the Fed and all other regulators that are now in forbearance crisis management stage where the objective is to avoid at any cost anything that may trigger a financial meltdown. Thus, most of these earnings reports are not worth the paper they are written off.
This earnings manipulation occurs in a variety of ways. First, ad hoc assumptions still used to value and write down level 2 and level 3 assets. Second, banks are leaving aside less reserves for loan losses that are much less than necessary; they do that by using ad hoc assumptions about future losses on mortgages, credit cards, auto loans, student loans, home equity loans and other commercial real estate loans and industrial and commercial loans. Reserves for loan losses have been sharply lagging actual and expected losses, thus padding earnings as decided by the financial institutions' managers. Third, there is disposal of illiquid and toxic assets in ways that misleadingly reduces the amount of actual writedowns. An example is as follows: suppose a bank wants to dump illiquid MBS or leveraged loans that are worth – mark to market – 70 cents on the dollar rather than 100 cents on the dollar. Then, instead of selling these at a price of 70 and showing a 30% writedown these are sold to hedge funds and other investors to a price closer to par – and thus showing in the balance sheet a smaller writedown – by providing a subsidy to the buyer of the security: so a hedge fund will buy such toxic securities at 80 or 90 cents and receive a loan to finance the transaction at an interest well below the borrowing costs for the funds. Thus, writedowns are then shown smaller than the true underlying loss on the asset and the bank finances that fudged transaction with earning less revenues than otherwise on its credit portfolio. This is an accounting scam- bordering on the criminal - that auditors and regulators are abetting on a regular basis.
The bailout plan of Fannie and Freddie implies a direct bailout of financial institutions and helps them to report better than expected earnings in two ways. First, since these financial institutions hold massive amounts of agency debt the government bailout of the holders of such unsecured debt props the market price of the agency debt (reduces its spread relative to Treasuries) and thus allows financial institutions and investors to report less mark to market losses on the values of such assets. Second, after the bust of subprime, near prime and prime mortgage markets the market for private label MBS is dead with absolutely no origination of new MBS. Thus, today – as senior mortgage market participant put it – Fannie and Freddie are “THE mortgage market” as the only institutions that securitize and guarantee mortgages are Fannie and Freddie. Without the government bailout plan that last channel for mortgage securitization and insurance would be frozen and the ability of banks to originate even prime and conforming mortgages would be serious hampered and its cost sharply increased. Thus, the Fannie and Freddie bailout is actually a bailout of the mortgage market and of every institution that holds agency debt or the MBS issued by the two GSES and of every institution that is in the mortgage origination business. On top of this Fannie and Freddie have also been used as tools of public policy in order to further grease the mortgage market and the banks originating mortgages: their portfolio limits were increased; their capital requirement reduced; and the limit for what a conforming loans – the only ones that Fannie and Freddie can securitize – increased from about $420K to over $720K.
The Fed has been actively beefing up the earnings and balance sheet of financial institutions in four major ways.
First, a 325bps reduction in the Fed Funds rate sharply reduced the cost of
borrowing for banks and allowed them to enjoy a nice intermediation margin (the
difference between longer terms interest rates at which they lend and the much
lower short term interest rates at which they borrow). This steepening of the
yield curve is a major subsidy to financial institutions.
Second, the Fed has created a range of new liquidity facilities – the TAF,
the TSLF, the PDCF – that allow banks and now non-bank primary dealers to swap
their illiquid toxic asset backed securities for liquid Treasuries and that
provide access for non-banks – and now also Fannie and Freddie - to the Fed’s
discount window liquidity.
Third, the bailout of Bear Stearns creditors – JP Morgan and many other
counterparties of Bear – not only avoided a systemic meltdown and a certain run
on the other broker dealers but it has led the Fed to take on a significant
credit risk by taking off the balance sheet of Bear Stearns over $29 billion of
toxic securities. So the Fed has directly and indirectly systemically subsidized
and propped up the financial system and the earnings of bank and non-bank
financial institutions.
Fourth, a variety of forbearance regulatory actions – starting with the
waiver of Regulation W for some major banks – have been used to beef up the
profits and earnings of financial institutions and reduce their reported
writedowns.
The entire Federal Home Loan Bank system – another GSE system that is another effective arm of the government - has been used to prop hundreds of mortgage lenders. The insolvent Countrywide alone received more than $51 billion of funds from this semi-public system. This is a system that has increased its lending in the last 18 months by hundreds of billions of dollars: Citigroup, Bank of America and most other US mortgage lenders have also been beneficiaries of this public subsidy to the tune of dozens of billions of dollars each.
In 1990-91 at the height of that recession and banking crisis many major banks – in addition to 1000 plus S&L's that went bust – were effectively insolvent, including, as it was well known at that time, Citibank. At that time the Fed and regulators used instruments similar to those used today – easy money and steepening of the intermediation yield curve, aggressive forbearance, creative – i.e. liar – accounting, etc. – to rescue these major financial institutions from formal bankruptcy. But at that time the housing bust and the ensuing decline in home prices was much smaller than today: during that recession home prices – as measured by the Case-Shiller/S&P index – fell less than 5% from their peak. This time around instead such an index has already fallen 18% from its peak and it will most likely fall by a cumulative 30% before it bottoms sometime in 2010. If a 5% fall in home prices was enough to make Citi effectively insolvent in 1991 what will a 30% fall in home prices – and massive defaults on many other forms of credit (commercial real estate loans, credit cards, auto loans, student loans, home equity loans, leveraged loans, muni bonds, industrial and commercial loans, corporate bonds, CDS) - do to these financial institutions? It challenges the credulity of even spin masters to argue that financial firms are not in worse shape today than they were in 1990-91 when a significant number of major banks were technically insolvent. So, not only hundreds of small banks and a significant fraction of regional banks but also some major money center banks will become effectively insolvent during this crisis.
In spite of the headline figures that showed better than expected earnings at some major financial institutions – Citi, JPM, Wells Fargo - the details were utterly ugly. For one thing, Merrill announced massive writedowns and losses that were much worse than expected. Second, even JPMorgan’s results details were worrisome: for example the recognition of a significant amount of rising losses on prime mortgages. In the case of Citi – a firm that has a presence in over 100 countries and whose revenues come, to a great extent, from foreign operations - there was a sharp increase in the losses on its consumer credit operations, including a large increase in delinquencies on credit cards both in the US and other markets (Brazil, Mexico). Thus, after having already shut down its money losing consumer credit operations in Japan, Citi is now experiencing a surge of delinquencies on unsecured consumer debt both at home and abroad. And the reserves set aside to take care of such expected loan losses are still woefully insufficient as they are based on very optimistic assumptions about the level at which such delinquencies will peak; this is another way to pad earnings and not recognize early on such losses. Systematic use of creative accounting is at work in all of these institutions and other banks and other financial institutions to hide the extent of the incoming losses on assets and loans.
With the excuse of wanting to crack down on “manipulators” the SEC has now imposed restrictions on short sales on the stocks of 19 major financial institutions including Fannie and Freddie. Let us be clear about this new rule: this is a clear and naked attempt by the SEC to manipulate upwards the price of equities of financial firms. The SEC should start investigation and legal action against itself for actively manipulating the stock market. And shame on the SEC for this most un-capitalist and manipulative action: when there is an upward bubble in stock prices and 95% of investors/speakers on CNBC are talking their books in that most public forum to manipulate upwards their portfolio the SEC does nothing and allows this charade to go on. But when short sellers are shorting the stocks of firms that are likely to be bust that is considered manipulation. That is a pretty pathetic action by the SEC that has artificially boosted the equity valuations of US financial firms – now up 20% plus in the last part of the past week after the introduction of this manipulative rule. And of course this manipulated increase in financials’ equity prices reduces the mark to market losses that banks and other financial firms holding such equities would have incurred, another additional way to pad upwards earnings.
The few and rare banks and mortgage/MBS analysts that were willing to provide a realistic assessment of the mortgage market and the financial conditions of US banks and brokers have been effectively muzzled by upper management. With the partial exception of Meredith Whitney who benefits from being at an independent research firm, many other analysts have gone into the spin mode that the Fed, the regulators and the senior management of these financial institutions have dictated to them. Sell-side research that was never independent – even after the additional Chinese walls that the corporate scandals of the early part of the decade led to – is even less independent today. So you have financial institutions manipulating at will their earnings and analysts falling for this supreme baloney.
The FDIC will for sure run out of money as hundreds of banks will go bust and their depositors will have to be made whole given deposit insurance. With funds of only $53 billion, already up to 15% of such funds will be used to rescue the depositors of IndyMac alone. Thus, the FDIC is already requesting to Congress that the deposit insurance premia should be raised to compensate for this shortfall of funding. Too bad that this increase in insurance premia – that should be high enough in advance (not ex-post) to ensure that deposit insurance is incentive-compatible and not leading to gambling for redemption via risky lending in banks – is now too little and too late and is requested when the damage is already done as the biggest credit bubble in U.S. history is now going bust. Also the FDIC has done a mediocre job at identifying which banks are at risk. So far there are only about 90 banks on its watch list; and IndyMac was not put on that list until last month! So if the FDIC did not even identify IndyMac as in trouble until it was too late, how many other IndyMacs are out there that that the FDIC has not identified yet? Certainly a few hundred but such honest analysis of banks at risk is nowhere to be found.
As I have argued in previous work all independent broker dealers are in deep trouble and may not survive – in a few years’ times – as independent firms. And some of them are already walking zombies. In a few years time there will be no major independent broker dealers as their business model (securitization, slice & dice and transfer of toxic credit risk and piling fees upon fees rather than earning income from holding credit risk) is bust and the risk of a bank-like run on their very short term liquid liabilities is a fundamental flaw in their structure. I.e. the four remaining U.S. big brokers dealers will either go bust or will have to be merged with traditional commercial banks. Indeed, firms that borrow liquid and short, highly leverage themselves and then lend in longer term and illiquid ways (i.e. most of the shadow banking system) cannot survive without formal deposit insurance and a formal permanent lender of last resort support from the central bank. (They did have quite a long run though - Jesse)
While a formal government bailout of most U.S. financial institutions has not occurred yet the U.S. government has avoided such bailout only by making sure that foreign government-owned institutions – the Sovereign Wealth Funds – did that job in lieu of the U.S. government. So instead of the U.S. government recapitalizing U.S. financial institutions we have seen foreign governments doing the job. Too bad that such SWFs have already lost 30% to 50% of their initial investments in such financial institutions. Thus, while U.S. financial firms will need hundreds of billions of additional capital injections to survive this crisis it is not obvious that foreign governments (SWFs) will not require conditions for such recapping (a percentage of equity that implies control, board membership, voting powers, common shares rather than preferred stock, etc.) that may not be politically acceptable in the U.S.
One could go on in more detail – as I have done in recent analyses – in discussing the severity of the current banking and financial crisis in the U.S. and how the official figures on earnings and balance sheets of financial institutions provide a misleading picture of the real financial state of such firms. As I argued before the $1 trillion of credit losses ($300-400 bn for mortgages and $600-700 bn for all the other non-mortgage credit) that I estimated last February are only a floor, not a ceiling, for such expected losses. Such losses are likely to end up being closer to my $2 trillion estimate. And such an estimate do not include the $200 to 300 billion that the rescue of Fannie and Freddie will entail. And such losses don’t even include scenarios where up to 50% of households who will end up underwater will walk away from their homes: that factor alone could entail mortgage losses of $1 trillion (average mortgage of $200k times the 50% loss that a foreclosure/walk away implies on that mortgage times 50% of the 21 million households that are underwater) rather than the $300-400 bn that I originally estimated.
So when you add it all up this will be the worst financial crisis since the Great Depression: not as severe as that episode but second only to it. And the real effects of this financial crisis will be severe and more severe if remedial policy action is not rapidly undertaken. Ditto for the US recession: this will be the worst of such U.S. recessions in decades.
One of the reasons we like Noriel Roubini is that he is an economist willing to dig into pertinent details, to get involved with current events, to take an intellectual stand and defend it, to tell it like it is, to borrow a phrase from another era.
This places him as a man apart from many of his economic peers, who lurk in obscure and largely irrelevant details, hiding behind rhetorical flourishes and courtly manners, lurking in the waiting rooms of universities and thinktanks, emerging every so often to speak for some vested interest with studies supporting pre-ordained conclusions. All of which of course is absolutely useless if not harmful to the real economy and legitimate achievement. But it does leave them open for research grants, and appointments, honorariums, and self-advancement within a corrupted system that rewards those who propagate it with the motto, go along to get along.
There is a management style in which achievement is rarely considered, although there is often an intricate if not baroque system of measures amenable to manipulation, but mistakes are penalized, and heavily. As one manager of a large business said in an interview, "If you do 99 things right, and one thing wrong, all they will remember is what you have done wrong and use it against you, depending on who you are."
And the shame is, he was right. The firm for which he worked had ceased to be a meritocracy, and instead had become an oligopoly in which influence-peddling and personal connections mattered above all, even as the business results deteriorated. Its vision and preoccupations turned increasingly inward on itself, almost obsessively. It eventually went bankrupt, formally, long after it had become functionally bankrupt. We saw this phenomenon at any number of mature companies we visited in the course of our consultancy.
Yes, there is that element of oligarchy in all societies, in all companies, in every organization, especially after they mature after a long period of relative stability, and unfortunately fall under the control of a few powerful people whose number one priority is self-perpetuation.
It is a matter of degree. When that modus operandi becomes predominant, pervasive, you have an organization that will surely soon be in trouble, and is headed towards a serious change of management, a major shakeup, a sometimes spectacular and precipitous failure, if it is subject to the forces of the markets.
So too it is with countries. This is what had happened to the former Soviet Union. And it is now happening to The United States and its financially-heavy economy. We have a bad case of the winner's curse. The dollar as the world's reserve currency fostered a deterioration of the American spirit that acted like slow poison on the vigor of the real economy.
The US is going to be passing through a purging of the system and its management for some time, measured in years but not decades, until it emerges again and can move forward.
The Coming Systemic Bust of the U.S. Banking System: “Dead Stocks Rallying”
Nouriel Roubini
Jul 20, 2008
RGE Monitor
This past week started with concerns about another systemic meltdown of the U.S. financial system as the insolvency of Fannie and Freddie was revealed and as IndyMac went bust (this third largest bank collapse in U.S. history). But the week ended with a remarkable rally of financial stocks as better than expected results from Wells Fargo, JP Morgan and Citi soothed the fears that major financial institutions were in even more distress than already predicted by market analysts.
Unfortunately, this massive rally of financial stocks in the latter part of the week is just another temporary bear market rally that will fizzle away once the onslaught of bad financial and macro news builds up again.
The views I presented in a recent blog that we will experience a severe financial and banking crisis received the support of many well respected commentators. Alan Abelson – at Barron’s – is one of the most senior and well known commentators on financial issues and on Wall Street. In his latest Barron’s column – aptly titled “Dead Stocks Rallying” he wrote:
WHY WE'RE STILL BEARISH WAS SPELLED out starkly in a dispatch we received last week from Nouriel Roubini. Nouriel is a professor of economics at NYU Stern School of Business (but don't hold that against him) and runs an economic
advisory firm called RGE Monitor that casts a knowing and clear eye on the
global financial and economic scene. We think he's top-notch (which means we
agree with him, a lot of the time).
The nub of his argument is that we're suffering the worst financial crisis since the Great Depression, and he proceeds to give chilling chapter and verse. He predicts that hundreds of small banks loaded with real estate will go bust and dozens of large regional and national banks will also find themselves in deep do-do.
He reckons that, in a few years, there'll be no major independent broker-dealers left: They'll either pack it in or merge, victims of excessive leverage and a badly flawed and discredited business model.
The Federal Deposit Insurance Corp., after it gets through picking up the pieces of IndyMac, will sooner or later have to get a capital transfusion, Nouriel asserts, because its insurance premiums won't cover the tab of rescuing all the troubled banks. He foresees credit losses ultimately reaching at least $1 trillion and anticipates a heap of woe for credit purveyors across the board.
The poor consumer, he contends, is shopped out and being hammered by falling home prices, falling equity prices, falling jobs and incomes, rising inflation. The recession he anticipates will last 12 to 18 months. And the rest of the world won't escape: He looks for hard landings for 12 major economies. As for the stock market, he hazards that there's plenty of room left on the downside. In fact, he feels the bear market won't end until equities are down a full 40% from their peaks.
We must say this vision is a mite too apocalyptic even for us. But Nouriel is not a
professional fear-monger out to make a splash with end-of-the-world
prognostications He's a sound guy with a solid record and an impressive résumé.
We obviously believe his views are worth pondering, even if they ruin your
appetite.
That was a very nice summary by Abelson of my views and a kind endorsement of them.
But how to square the views that a large fraction of the US financial system is in trouble with the apparently better than expected earnings results and lower than expected writedowns presented by financial institutions such as Wells Fargo, JP Morgan and Citi that led to the financials’ stocks most recent rally? There are many reasons why those earnings results are misleading and cosmetically retouched upward while the true financial conditions of the financial system are more dire than otherwise presented.
Let us discuss next in some detail the various reasons why financial conditions of financial firms and banks are much worse than those headline figures and why we the US will experience a systemic financial crisis…
First of all, in a week when only a massive and open ended bailout rescued Fannie and Freddie, when IndyMac went bust and when Merrill presented much worse than expected results it is very hard to be optimistic about the health of the US financial institutions. Reports in the next few days will reveal whether reality is closer to Fannie/Freddie/IndyMac/Merrill or rather closer to the Citi/JPMorgan/Wells Fargo outlook.
Most financial institutions are putting increasing numbers of assets in the illiquid buckets of Level 2 and Level 3 assets. While FASB 157 should prevent manipulation of the valuation of such illiquid assets, forbearance by the SEC, the Fed and other regulators allows a massive amount of fudging.
An insider told me that in a major financial institution the approach is as follows now: top management decide in advance what the announced writedowns should be and folks dealing with the toxic/illiquid assets come up with totally ad hoc assumptions to make sure that such illiquid assets are valued consistently with the decided-in-advance amount of writedowns and losses.
This is not earnings smoothing; this is active manipulation and falsification of financial results aimed at creating even more obfuscation of the true state of financial institutions. This obfuscation is actively abetted by the SEC, the Fed and all other regulators that are now in forbearance crisis management stage where the objective is to avoid at any cost anything that may trigger a financial meltdown. Thus, most of these earnings reports are not worth the paper they are written off.
This earnings manipulation occurs in a variety of ways. First, ad hoc assumptions still used to value and write down level 2 and level 3 assets. Second, banks are leaving aside less reserves for loan losses that are much less than necessary; they do that by using ad hoc assumptions about future losses on mortgages, credit cards, auto loans, student loans, home equity loans and other commercial real estate loans and industrial and commercial loans. Reserves for loan losses have been sharply lagging actual and expected losses, thus padding earnings as decided by the financial institutions' managers. Third, there is disposal of illiquid and toxic assets in ways that misleadingly reduces the amount of actual writedowns. An example is as follows: suppose a bank wants to dump illiquid MBS or leveraged loans that are worth – mark to market – 70 cents on the dollar rather than 100 cents on the dollar. Then, instead of selling these at a price of 70 and showing a 30% writedown these are sold to hedge funds and other investors to a price closer to par – and thus showing in the balance sheet a smaller writedown – by providing a subsidy to the buyer of the security: so a hedge fund will buy such toxic securities at 80 or 90 cents and receive a loan to finance the transaction at an interest well below the borrowing costs for the funds. Thus, writedowns are then shown smaller than the true underlying loss on the asset and the bank finances that fudged transaction with earning less revenues than otherwise on its credit portfolio. This is an accounting scam- bordering on the criminal - that auditors and regulators are abetting on a regular basis.
The bailout plan of Fannie and Freddie implies a direct bailout of financial institutions and helps them to report better than expected earnings in two ways. First, since these financial institutions hold massive amounts of agency debt the government bailout of the holders of such unsecured debt props the market price of the agency debt (reduces its spread relative to Treasuries) and thus allows financial institutions and investors to report less mark to market losses on the values of such assets. Second, after the bust of subprime, near prime and prime mortgage markets the market for private label MBS is dead with absolutely no origination of new MBS. Thus, today – as senior mortgage market participant put it – Fannie and Freddie are “THE mortgage market” as the only institutions that securitize and guarantee mortgages are Fannie and Freddie. Without the government bailout plan that last channel for mortgage securitization and insurance would be frozen and the ability of banks to originate even prime and conforming mortgages would be serious hampered and its cost sharply increased. Thus, the Fannie and Freddie bailout is actually a bailout of the mortgage market and of every institution that holds agency debt or the MBS issued by the two GSES and of every institution that is in the mortgage origination business. On top of this Fannie and Freddie have also been used as tools of public policy in order to further grease the mortgage market and the banks originating mortgages: their portfolio limits were increased; their capital requirement reduced; and the limit for what a conforming loans – the only ones that Fannie and Freddie can securitize – increased from about $420K to over $720K.
The Fed has been actively beefing up the earnings and balance sheet of financial institutions in four major ways.
First, a 325bps reduction in the Fed Funds rate sharply reduced the cost of
borrowing for banks and allowed them to enjoy a nice intermediation margin (the
difference between longer terms interest rates at which they lend and the much
lower short term interest rates at which they borrow). This steepening of the
yield curve is a major subsidy to financial institutions.
Second, the Fed has created a range of new liquidity facilities – the TAF,
the TSLF, the PDCF – that allow banks and now non-bank primary dealers to swap
their illiquid toxic asset backed securities for liquid Treasuries and that
provide access for non-banks – and now also Fannie and Freddie - to the Fed’s
discount window liquidity.
Third, the bailout of Bear Stearns creditors – JP Morgan and many other
counterparties of Bear – not only avoided a systemic meltdown and a certain run
on the other broker dealers but it has led the Fed to take on a significant
credit risk by taking off the balance sheet of Bear Stearns over $29 billion of
toxic securities. So the Fed has directly and indirectly systemically subsidized
and propped up the financial system and the earnings of bank and non-bank
financial institutions.
Fourth, a variety of forbearance regulatory actions – starting with the
waiver of Regulation W for some major banks – have been used to beef up the
profits and earnings of financial institutions and reduce their reported
writedowns.
The entire Federal Home Loan Bank system – another GSE system that is another effective arm of the government - has been used to prop hundreds of mortgage lenders. The insolvent Countrywide alone received more than $51 billion of funds from this semi-public system. This is a system that has increased its lending in the last 18 months by hundreds of billions of dollars: Citigroup, Bank of America and most other US mortgage lenders have also been beneficiaries of this public subsidy to the tune of dozens of billions of dollars each.
In 1990-91 at the height of that recession and banking crisis many major banks – in addition to 1000 plus S&L's that went bust – were effectively insolvent, including, as it was well known at that time, Citibank. At that time the Fed and regulators used instruments similar to those used today – easy money and steepening of the intermediation yield curve, aggressive forbearance, creative – i.e. liar – accounting, etc. – to rescue these major financial institutions from formal bankruptcy. But at that time the housing bust and the ensuing decline in home prices was much smaller than today: during that recession home prices – as measured by the Case-Shiller/S&P index – fell less than 5% from their peak. This time around instead such an index has already fallen 18% from its peak and it will most likely fall by a cumulative 30% before it bottoms sometime in 2010. If a 5% fall in home prices was enough to make Citi effectively insolvent in 1991 what will a 30% fall in home prices – and massive defaults on many other forms of credit (commercial real estate loans, credit cards, auto loans, student loans, home equity loans, leveraged loans, muni bonds, industrial and commercial loans, corporate bonds, CDS) - do to these financial institutions? It challenges the credulity of even spin masters to argue that financial firms are not in worse shape today than they were in 1990-91 when a significant number of major banks were technically insolvent. So, not only hundreds of small banks and a significant fraction of regional banks but also some major money center banks will become effectively insolvent during this crisis.
In spite of the headline figures that showed better than expected earnings at some major financial institutions – Citi, JPM, Wells Fargo - the details were utterly ugly. For one thing, Merrill announced massive writedowns and losses that were much worse than expected. Second, even JPMorgan’s results details were worrisome: for example the recognition of a significant amount of rising losses on prime mortgages. In the case of Citi – a firm that has a presence in over 100 countries and whose revenues come, to a great extent, from foreign operations - there was a sharp increase in the losses on its consumer credit operations, including a large increase in delinquencies on credit cards both in the US and other markets (Brazil, Mexico). Thus, after having already shut down its money losing consumer credit operations in Japan, Citi is now experiencing a surge of delinquencies on unsecured consumer debt both at home and abroad. And the reserves set aside to take care of such expected loan losses are still woefully insufficient as they are based on very optimistic assumptions about the level at which such delinquencies will peak; this is another way to pad earnings and not recognize early on such losses. Systematic use of creative accounting is at work in all of these institutions and other banks and other financial institutions to hide the extent of the incoming losses on assets and loans.
With the excuse of wanting to crack down on “manipulators” the SEC has now imposed restrictions on short sales on the stocks of 19 major financial institutions including Fannie and Freddie. Let us be clear about this new rule: this is a clear and naked attempt by the SEC to manipulate upwards the price of equities of financial firms. The SEC should start investigation and legal action against itself for actively manipulating the stock market. And shame on the SEC for this most un-capitalist and manipulative action: when there is an upward bubble in stock prices and 95% of investors/speakers on CNBC are talking their books in that most public forum to manipulate upwards their portfolio the SEC does nothing and allows this charade to go on. But when short sellers are shorting the stocks of firms that are likely to be bust that is considered manipulation. That is a pretty pathetic action by the SEC that has artificially boosted the equity valuations of US financial firms – now up 20% plus in the last part of the past week after the introduction of this manipulative rule. And of course this manipulated increase in financials’ equity prices reduces the mark to market losses that banks and other financial firms holding such equities would have incurred, another additional way to pad upwards earnings.
The few and rare banks and mortgage/MBS analysts that were willing to provide a realistic assessment of the mortgage market and the financial conditions of US banks and brokers have been effectively muzzled by upper management. With the partial exception of Meredith Whitney who benefits from being at an independent research firm, many other analysts have gone into the spin mode that the Fed, the regulators and the senior management of these financial institutions have dictated to them. Sell-side research that was never independent – even after the additional Chinese walls that the corporate scandals of the early part of the decade led to – is even less independent today. So you have financial institutions manipulating at will their earnings and analysts falling for this supreme baloney.
The FDIC will for sure run out of money as hundreds of banks will go bust and their depositors will have to be made whole given deposit insurance. With funds of only $53 billion, already up to 15% of such funds will be used to rescue the depositors of IndyMac alone. Thus, the FDIC is already requesting to Congress that the deposit insurance premia should be raised to compensate for this shortfall of funding. Too bad that this increase in insurance premia – that should be high enough in advance (not ex-post) to ensure that deposit insurance is incentive-compatible and not leading to gambling for redemption via risky lending in banks – is now too little and too late and is requested when the damage is already done as the biggest credit bubble in U.S. history is now going bust. Also the FDIC has done a mediocre job at identifying which banks are at risk. So far there are only about 90 banks on its watch list; and IndyMac was not put on that list until last month! So if the FDIC did not even identify IndyMac as in trouble until it was too late, how many other IndyMacs are out there that that the FDIC has not identified yet? Certainly a few hundred but such honest analysis of banks at risk is nowhere to be found.
As I have argued in previous work all independent broker dealers are in deep trouble and may not survive – in a few years’ times – as independent firms. And some of them are already walking zombies. In a few years time there will be no major independent broker dealers as their business model (securitization, slice & dice and transfer of toxic credit risk and piling fees upon fees rather than earning income from holding credit risk) is bust and the risk of a bank-like run on their very short term liquid liabilities is a fundamental flaw in their structure. I.e. the four remaining U.S. big brokers dealers will either go bust or will have to be merged with traditional commercial banks. Indeed, firms that borrow liquid and short, highly leverage themselves and then lend in longer term and illiquid ways (i.e. most of the shadow banking system) cannot survive without formal deposit insurance and a formal permanent lender of last resort support from the central bank. (They did have quite a long run though - Jesse)
While a formal government bailout of most U.S. financial institutions has not occurred yet the U.S. government has avoided such bailout only by making sure that foreign government-owned institutions – the Sovereign Wealth Funds – did that job in lieu of the U.S. government. So instead of the U.S. government recapitalizing U.S. financial institutions we have seen foreign governments doing the job. Too bad that such SWFs have already lost 30% to 50% of their initial investments in such financial institutions. Thus, while U.S. financial firms will need hundreds of billions of additional capital injections to survive this crisis it is not obvious that foreign governments (SWFs) will not require conditions for such recapping (a percentage of equity that implies control, board membership, voting powers, common shares rather than preferred stock, etc.) that may not be politically acceptable in the U.S.
One could go on in more detail – as I have done in recent analyses – in discussing the severity of the current banking and financial crisis in the U.S. and how the official figures on earnings and balance sheets of financial institutions provide a misleading picture of the real financial state of such firms. As I argued before the $1 trillion of credit losses ($300-400 bn for mortgages and $600-700 bn for all the other non-mortgage credit) that I estimated last February are only a floor, not a ceiling, for such expected losses. Such losses are likely to end up being closer to my $2 trillion estimate. And such an estimate do not include the $200 to 300 billion that the rescue of Fannie and Freddie will entail. And such losses don’t even include scenarios where up to 50% of households who will end up underwater will walk away from their homes: that factor alone could entail mortgage losses of $1 trillion (average mortgage of $200k times the 50% loss that a foreclosure/walk away implies on that mortgage times 50% of the 21 million households that are underwater) rather than the $300-400 bn that I originally estimated.
So when you add it all up this will be the worst financial crisis since the Great Depression: not as severe as that episode but second only to it. And the real effects of this financial crisis will be severe and more severe if remedial policy action is not rapidly undertaken. Ditto for the US recession: this will be the worst of such U.S. recessions in decades.
3 July 2008
Small US banks doomed, aussie banks will follow
Wall Street is bracing for regional and small banks to fess up to large losses from their mounting volume of soured construction loans made primarily to home builders.
According to the Federal Deposit Insurance Corp., $45.4 billion of the $631.8 billion in construction loans outstanding at the end of the first quarter were delinquent. When banks announce second-quarter results in coming weeks, they are expected to report sharp increases in loans that builders can't repay. Banks are also facing intensifying pressure from federal and state regulators to deal with the problem loans on their books.
That will put additional pressure on an already stressed financial system. Banks have begun to dump bad construction and land loans at discounts, curtail new lending and halt construction projects that are under way to preserve capital. Some analysts even see a wave of bank failures as a possibility.
"Across the industry, the second quarter is going to be a tough quarter," says Keith Maio, chief executive of the National Bank of Arizona, a unit of Zions Bancorp, which lent heavily to home builders and developers. "It's going to continue to be tough until the real-estate market hits a bottom."
Scores of banks were already suffering headaches by the end of the first quarter, according to a review by The Wall Street Journal of FDIC-filed reports by 6,919 banks that make construction loans. The smallest banks, those with total assets of less than $5 billion, faced the biggest problems. The WSJ analysis didn't include savings-and-loan institutions, or so-called thrift banks.
Nearly one in three of the banks analyzed -- or 2,182 -- had construction-loan portfolios that exceeded 100% of their total risk-based capital, a red flag to regulators, although it doesn't mean the bank is in danger of failing. Risk-based capital is a cushion that banks can dig into to cover losses.
Even more alarming, 73 of those banks had construction-loan delinquency rates of more than 25%. Executives at all of the banks that responded to questions acknowledged the problems but expressed confidence they had the capital to weather the storm.
At Bremerton, Wash.-based Westsound Bank, new Chief Executive Terry Peterson agreed that his bank became "much, much too concentrated" in construction loans. About 43% of Westsound Bank's construction and land loans in the first quarter were delinquent.
Mr. Peterson was appointed CEO recently to clean up the troubled bank, after regulators issued a "cease and desist" order in March requiring the bank to change lending practices. "We are pretty much using all of our human capital to address our loan problems," he says.
Larger regional banks also face mounting construction-loan problems, but are in decent shape. Thirty-eight of them had more than 100% of their total risk-based capital in construction loans at the end of the first quarter, but only nine of those faced delinquency rates of more than 10%.
Over the next few quarters, banks are expected to begin recording much larger losses. In 2007 and the first quarter of this year, U.S. banks wrote down just 0.7% of their residential construction and land assets as bad debt, according to Zelman & Associates, a research firm. Over the next five years that figure could rise to 10% and 26%, which would amount to about $65 billion to $165 billion, Zelman projects.
During the housing boom, many small and regional banks doubled down on construction loans because they were largely shut out of the home mortgage market dominated by large originators. But now the banks' difficulties are threatening to sharply shrink the home-building industry. Credit Suisse analyst Dan Oppenheim estimates that as many as 50% of the closely held builders won't survive because of the tightening lending environment and housing downturn.
Strategies for coping with the problem loans vary widely. Large banks, such as IndyMac Bancorp Inc. and KeyBank, have been trying to sell billions of dollars of construction and land loans. IndyMac said in a filing Monday that it is working with regulators to shore up its capital. (See related article2.)
"The banks are running as fast as they can to get out of housing," says Tom McCormick, president of Astoria Homes, a large, closely held builder in Las Vegas.
Mr. McCormick is involved in a fight with KeyBank, which recently initiated foreclosure proceedings on a $24 million construction loan financing a Las Vegas housing project. Mr. McCormick says the bank took that action even though his company was current on debt payments. In court documents, KeyBank says the builder fell behind.
Mr. McCormick says he found investors to buy out his loans at 70 cents on the dollar, but the bank refused. He also says that KeyBank has prevented him from closing home sales. "I personally think the fact that you would punish any innocent home buyer...is shameful," Mr. McCormick wrote in an email to KeyBank executives. A spokeswoman for KeyCorp, KeyBank's parent, declined to comment.
Many smaller banks have been more willing to work with struggling builders rather than foreclose on their projects. But these banks are coming under pressure from regulators to more aggressively write down their loans, amid declining real-estate values. This process could force many more loans into default.
Some community banks are bristling under the regulatory pressure. "The federal government is being too reactionary," says Damian Kassab, chief executive of Michigan-based Warren Bank, which reported that 47% of its construction loans are delinquent. "They want to see it done as quickly as possible. I say 'can't we just relax, take a deep breath and work with the borrowers.'"
Analysts question whether some small banks are putting off foreclosures because they lack adequate capital to absorb the large losses.
Banks seeking a quick fix by selling off their troubled loans may find fewer buyers. Laurence Pelosi, an executive director of Morgan Stanley Real Estate, a major land investor, told the Pacific Coast Builders Conference last week that the appetite for distressed residential real estate may be waning among some investors. "The complexity of the business and the increasing opportunities in the commercial sector may lead to a shift away from residential," Mr. Pelosi says. "That will have a further impact on values."
26 April 2008
18 June 2007
speculative credit excess
Bears' Chat - Welcome: "In a foreword to the report, Crispin Odey, CEO of Odey Asset Management, says: 'Not only does he [Chancellor] make a cogent and persuasive case that current trends are unsustainable, but his unique knowledge of the hinterland of previous periods of speculative credit excess also illuminates the range of potential outcomes...There is no question that financial markets are not priced for the sorts of risks that Chancellor identifies.'
Well, Chancellor's latest: Inefficient Market: Blackstone Letter, may indeed prove prescient. It was posted here earlier, and presents what to me is a plausible outcome to the financial madness so rampant today. Once again, the salient points:
'Looking back over this difficult period, most of our problems can be ascribed to deteriorating economic conditions; extraordinary convulsions in the credit markets; a worsening political and legal environment for the buyout industry; and the consequences of what is now commonly referred to as the 'private equity bubble.' I will briefly examine each of these issues in turn.'
1. The Macro-Economic Climate: When Blackstone came to the market in the summer of 2007, economic conditions were remarkably benign. Most economists agree that the decision by Congress to impose punitive tariffs on Chinese imports during the "
Well, Chancellor's latest: Inefficient Market: Blackstone Letter, may indeed prove prescient. It was posted here earlier, and presents what to me is a plausible outcome to the financial madness so rampant today. Once again, the salient points:
'Looking back over this difficult period, most of our problems can be ascribed to deteriorating economic conditions; extraordinary convulsions in the credit markets; a worsening political and legal environment for the buyout industry; and the consequences of what is now commonly referred to as the 'private equity bubble.' I will briefly examine each of these issues in turn.'
1. The Macro-Economic Climate: When Blackstone came to the market in the summer of 2007, economic conditions were remarkably benign. Most economists agree that the decision by Congress to impose punitive tariffs on Chinese imports during the "
8 June 2007
Sydney defaults hidden away
THE number of home repossessions around the nation is up to four times higher than reported figures because lenders are disguising the nature of forced sales to prop up property prices.
Australia's biggest private debt collector, Prushka, yesterday said about three-quarters of sales forced by bank and non-bank lenders were co-ordinated with the consent of home owners, meaning they were not recorded in court repossession figures.
"By far the most popular way for lenders is to sell the property with the consent of the borrower to avoid advertising the property as a forced sale," Prushka chief executive Roger Mendelson said.
"The idea is to work with the seller because if they sell the property as a mortgagee in possession that will slaughter the price because you're going to attract the bargain hunters."
Mr Mendelson said statements by Peter Costello yesterday that Australia had a low home loan "default rate" - where borrowers can't meet mortgage repayments - failed to address the impact of increasing unreported levels of repossessions.
During a discussion about US default rates hitting an all-time high in the first quarter of 2007, the Treasurer had told Macquarie Regional Radio: "The default rate in Australia is much, much lower than it is in the US ... in fact, we have one of the lowest default rates in the world."
Experts said rising interest rates, coupled with the prevalence of low-documentation loans that do not force borrowers to disclose their income, had caused a spike in mortgage defaults in Australia.
Ian Graham, chief executive of PMI Mortgage Insurance, which insures about one million home loans, said Australia had no register for compiling total home repossessions.
"We would like to see a register introduced - I think the Reserve Bank would be one body in particular that would benefit from more complete data," Mr Graham said.
State "writs of possession" registers record only sales where lenders are forced to apply for repossession orders.
Sydney's outer western suburbs are being hardest hit by the surge in repossessions.
In NSW, 5363 writs of possession were issued last year - up 10 per cent on 2005.
Figures from the Victorian Supreme Court show there were 2791 repossession claims lodged last year, up from 2578 in 2005. The figure has more than doubled since 2003, when there were 1225.
"In southwest, west and northwest Sydney, property prices are weakest and in forced-sale situations property price declines of between 20 and 25 per cent are not unusual," Mr Graham said.
Dara Dhillon, principal of Dhillon Real Estate in Ingleburn in Sydney's outer southwest, said 90 per cent of properties coming to the market were forced sales, and the number of homes hitting the market was rising.
"It's actually getting worse by the month - in one family I was working with, the elderly mother had to return to work to keep a roof over their heads," he said.
But he said that with high employment and healthy wages growth, it was last year's interest rate rises and lax lending policies of non-bank lenders - especially "low-doc" loans where borrowers are not required to prove their income - that were to blame for the current fallout.
"It's a joke - if it was my money I wouldn't lend it but I believe lenders are still doing it," he said. "Low-doc, no-doc, whatever doc - doc doesn't even come into the picture."
Australia's biggest private debt collector, Prushka, yesterday said about three-quarters of sales forced by bank and non-bank lenders were co-ordinated with the consent of home owners, meaning they were not recorded in court repossession figures.
"By far the most popular way for lenders is to sell the property with the consent of the borrower to avoid advertising the property as a forced sale," Prushka chief executive Roger Mendelson said.
"The idea is to work with the seller because if they sell the property as a mortgagee in possession that will slaughter the price because you're going to attract the bargain hunters."
Mr Mendelson said statements by Peter Costello yesterday that Australia had a low home loan "default rate" - where borrowers can't meet mortgage repayments - failed to address the impact of increasing unreported levels of repossessions.
During a discussion about US default rates hitting an all-time high in the first quarter of 2007, the Treasurer had told Macquarie Regional Radio: "The default rate in Australia is much, much lower than it is in the US ... in fact, we have one of the lowest default rates in the world."
Experts said rising interest rates, coupled with the prevalence of low-documentation loans that do not force borrowers to disclose their income, had caused a spike in mortgage defaults in Australia.
Ian Graham, chief executive of PMI Mortgage Insurance, which insures about one million home loans, said Australia had no register for compiling total home repossessions.
"We would like to see a register introduced - I think the Reserve Bank would be one body in particular that would benefit from more complete data," Mr Graham said.
State "writs of possession" registers record only sales where lenders are forced to apply for repossession orders.
Sydney's outer western suburbs are being hardest hit by the surge in repossessions.
In NSW, 5363 writs of possession were issued last year - up 10 per cent on 2005.
Figures from the Victorian Supreme Court show there were 2791 repossession claims lodged last year, up from 2578 in 2005. The figure has more than doubled since 2003, when there were 1225.
"In southwest, west and northwest Sydney, property prices are weakest and in forced-sale situations property price declines of between 20 and 25 per cent are not unusual," Mr Graham said.
Dara Dhillon, principal of Dhillon Real Estate in Ingleburn in Sydney's outer southwest, said 90 per cent of properties coming to the market were forced sales, and the number of homes hitting the market was rising.
"It's actually getting worse by the month - in one family I was working with, the elderly mother had to return to work to keep a roof over their heads," he said.
But he said that with high employment and healthy wages growth, it was last year's interest rate rises and lax lending policies of non-bank lenders - especially "low-doc" loans where borrowers are not required to prove their income - that were to blame for the current fallout.
"It's a joke - if it was my money I wouldn't lend it but I believe lenders are still doing it," he said. "Low-doc, no-doc, whatever doc - doc doesn't even come into the picture."
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