Friday, April 17, 2009

The "Snickers Recession"

[Source: U.S. Census Bureau]

Gonna be here awhile? Yes, we are. Some people look around and think they see "green shoots" springing up in the economy--you know, the same way pilgrims to religious shrines swear they see tears running down the cheeks of Mother Mary. Look at an inert object long enough, and you will eventually see what you want to see. The human brain, after all, is hard-wired to look for change.

The graph above is an ill omen for an economy built on rampant consumerism. It says that stuff is just not selling. While business inventories in the U.S. fell in February by 1.3% (a welcome precursor to recovery), sales fell as well, leaving the inventory-to-sales ratio virtually unchanged. That ratio needs to come down before businesses decide to ramp up orders. The best that can be said about the economy, according to Paul Krugman in today's N.Y. Times, is that "things are getting worse more slowly."

Bank stocks have rallied furiously in the last six weeks, leading some to believe that better times are just ahead. This morning Citigroup (trading at just a buck not too long ago) reported a lower-than-expected loss. Earlier this week Goldman Sachs and JPMorgan Chase also posted decent results. But can those profits be replicated in quarters to come? I say no, and here's why. First, last year's fourth quarter was a "kitchen-sink" quarter for the banks, which all took massive write-downs to make this year's Q1 look good by comparison. In fact, Goldman, in a clever piece of bookkeeping legerdemain, orphaned its hideous month of December by changing its fiscal year!

Second, most of the recent profits were generated by trading activity, where the firms either placed bets on securities themselves or collected fees from other investors doing the same thing. Heightened volatility in the stock market enabled these players to harvest sizable short-term gains. When the market takes its next leg down--and it will--volatility will get crushed, along with the trading positions. Then the banks' investment divisions will get back to doing what they did all of last year: taking losses.

Third, banks will be forced to write down heavily, perhaps as early as the second quarter (the one we are in now), for looming losses in home mortgages, credit-card debt, and commercial loans. Anticipating more pain ahead, JPMorgan increased its loan-loss reserves by $10 billion, or over 50%. Goldman is getting ready for the next wave of defaults by issuing $5 billion in new stock, signaling both that it will need the cash and that it does not expect its stock price to advance from here. Betting on a recovery is betting against Goldman.

Mainers were just reminded of a fourth headwind facing the economy: imminent corporate bankruptcies. Yesterday Portland's television reporters, as they usually do when they want "hard" news on the economy, went to the Maine Mall to talk to shoppers, who were asked about the announcement that the mall's owner, General Growth Properties, Inc., was filing for Chapter 11 bankruptcy protection. None of the shoppers knew that GGP was being pushed to walk the plank by bondholders. Normally bondholders avoid the courts for fear of a haircut, but no longer. As the Financial Times reports, those protected by credit default swaps (CDS) are now highly motivated to push for bankruptcy, which triggers face-value payouts on the bonds. That default insurance was written by the AIGs of the world.

Which means that, thanks to the TARP bailout, you and I will be paying it.

[update, 05-18-09:]
At an auction last week to settle the credit default swaps on GGP's bonds, the secured debt was priced at $0.43 on the dollar, which would seem to put federal taxpayers on the hook for the other $0.57. Worse, the discount signals no visible end to the crash in commercial real estate.

Tuesday, April 14, 2009

Dennis Is Wall Street's Menace

Congressional oversight is often lacking, but not now. U.S. Representative Dennis Kucinich of Ohio is not your typical capitalistic crony, warming a seat on Capitol Hill while cozying up to wealthy campaign donors. He means business--and means for Big Business to be accountable.

While polling single digits as a presidential candidate in 2004 and 2008, Kucinich insisted that he was Main Street's guy. "The rest of these people," he said of his opponents, "are candidates of a radical corporate structure that takes the wealth of the nation and puts it in the hands of a few." He opposed the TARP legislation passed by Congress last fall, concerned that Treasury Secretary Henry Paulson, an ex-Wall Streeter, was being granted too much power. It was like appointing a fox to guard the hen-house.

Hens should now feel comforted. As Chair of the House Domestic Policy Subcommittee, Kucinich serves as the resident bad-ass rooster on steroids. Last week he went after Bank of America, suggesting in a letter to the Securities and Exchange Commission that the mega-bank had duped its shareholders by withholding material information prior to December's vote approving the merger with Merrill Lynch. Specifically, shareholders should have been alerted about billions in bonuses to be paid to outgoing Merrill executives, bonuses that Kucinich derides as "little more than a farewell gift from senior management to themselves." [For more on the New York Attorney General's investigation into the bonuses, go here.]

Bank of America's stock has been trading like a champ, more than tripling in six weeks. Investors obviously feel that the government has BofA's back and that taxpayers will pick up the tab for civil penalties stemming from any violation of SEC regulations. Meanwhile, Dennis the Menace is prodding the Treasury Department and Federal Reserve to reveal what they knew about the bonuses--and when. After all, they were essentially conservators of the damaged Merrill franchise ever since the September announcement that Bank of America would be taking over. Watch feathers fly if Kucinich can prove a cover-up.

[update, 04-23-09:]
The Wall Street Journal is reporting this morning that Treasury Secretary Hank Paulson and Fed Chair Ben Bernanke encouraged BofA CEO Ken Lewis, in effect, to commit securities fraud. Quoting the report, "Mr. Lewis, testifying under oath before New York's attorney general in February, told prosecutors that he believed Messrs. Paulson and Bernanke were instructing him to keep silent about deepening financial difficulties at Merrill, the struggling brokerage giant." Not only that, Paulson and Bernanke threatened to fire Lewis and to remove BofA's entire Board of Directors if the company persisted in trying to back out of the Merrill deal. The AG's letter to Congress, just released, can be found here.

Tuesday, April 7, 2009

Friday, April 3, 2009

"A New Level of Absurdity"

Cut the Congressman some slack, please.
U. S. Representative Spencer Bachus of Alabama, the ranking Republican on the House Financial Services Committee, is extra cranky these days from massive indigestion--dysPPIPsia, if you will. He has been reviewing the Treasury Secretary's latest plan to relieve America's biggest banks of toxic assets, and he smells a rat. The last straw came last night when a Financial Times reporter intimated that banks were seriously considering buying such assets, not selling them. Or maybe buying and selling them. Bachus is outraged, and you are...confused?

O.K., let's walk through this slowly. First, some background. Recall that last July Merrill Lynch tried to find a buyer for $30 billion worth of toxic assets that the company was carrying on its books. Lo and behold, they found one: Lone Star Funds, a private-equity firm based in Dallas. Lone Star agreed to pay 22 cents on the dollar for this crap, but only if Merrill would finance 75% of the purchase with no added collateral. In effect, Lone Star was risking only 5.5 cents on the dollar. Merrill, however, got to book 22, a price inflated by the leverage involved.

Tim Geithner's PPIP (acronym for "Piss-poor Plan for Inflated Pricing"--no, just kidding) attempts to jump-start the moribund toxic-assets market with the exact same mechanism: use leverage to mark up the asset prices. Let's go back to the Merrill example. Merrill had more toxic assets than the $30 billion it sold to Lone Star, a lot more. Now Bank of America has them after agreeing to take out Merrill in September. Upon closer inspection, Bank of America found Merrill's portfolio to be so toxic that it tried to back out of the deal in December. But Treasury had the shotgun, and Bank of America had to acquiesce (though Treasury sweetened the deal with another $20 billion in TARP dough).

So how is Bank of America going to find buyers for the old Merrill junk? Simple. Use PPIP. Bank of America agrees to finance up to 86% of the purchase, the same way Merrill did with Lone Star. One major difference: the FDIC guarantees the loan, which means Bank of America will never have to write it off. Second major difference: the U.S. Treasury partners with the private-sector buyer 50:50. Third major difference: the Federal Reserve finances a portion (exact percentage to be determined) of the private-sector equity offer. The whole scheme is a Rube-Goldberg contraption designed to lever up an itty-bitty private-partner bet into an artificially high sticker price that Bank of America and its peers can then use to mark up their portfolios and boost their tangible capital ratios.

Also benefitting will be the Pimcos and BlackRocks of the world who hold corporate bonds issued by Bank of America et al. In fact, they are among the privileged few handpicked by Treasury to bid for toxic assets, some of which they already own. The worst thing that can happen to them is that they place their bets on mortgage-backed securities, collect the coupon while they wait for price appreciation, and walk away from their loans if the assets tank further (not unlikely). They still profit on the turn-around, and meanwhile their bond positions have recovered. The banks, their balance sheets fortified, take a giant step back from insolvency. Pimco's Bill Gross calls it a win-win-win. [update, 07-09-09: make that win-lose-draw. Pimco has withdrawn from the PPIP auction amid new "uncertainties" about the program's design.]

The third winner in that equation is supposed to be the taxpayer. But this is a zero-sum game, with no new wealth created. Somewhere, somehow, there has to be a loser. Minyanville's Mr. Practical points to the taxpayer: "banks on average have most of their illiquid assets marked at $.60 on the dollar, while a private investor in order to risk money might be willing to pay $.30 on the dollar. If this is going to work, the government (you) will have to make up the difference, which could be around $3 while the program will show initial success (it’s most likely all pre-arranged) on a small amount of assets, it will eventually expose more losses down the road and more need for capital."

Private-equity managers are salivating at the opportunity. Tom Barrack, founder of Colony Capital, wants to raise $4 billion to buy distressed banking assets. In an interview with the Financial Times, Barrack opines that the traditional private-equity model just doesn't work like it used to. “Private capital needs to change its thinking. Today, the opportunity is to become a regulated institution, not to run away from regulation,” he said. Translation: the only suckers left are taxpayers. As Dr. John Hussman of Hussman Funds explains: "You can play hot potato with the toxic assets all day long, and the only outcome will be that the public will suffer the losses that would otherwise have been properly taken by the banks' own bondholders."

But taxpayers, as well as their duly elected representatives, are starting to wise up. The claw-backs of bonuses awarded to AIG managers are a warning that obscene profits under PPIP will not go unnoticed and may be subject to punitive retroactive taxation. Rep. Bachus promises to do what he can to stop Wall Street from "gaming the system to reap taxpayer-subsidized windfalls.” Make sure your rep does as well.

[update, 04-07-09:]
Wall Street Journal is reporting this morning that the Treasury Department, following criticism that PPIP 1.0 practically guarantees premium prices for toxic assets, will open up the bidding process to smaller investors. More competition means better pricing--and better protection for taxpayers. Also depressing prices is the sheer supply of toxic debt, which is increasing faster than Treasury can auction it off. The International Monetary Fund now estimates that toxic debt will balloon to over $4 trillion in the months ahead. That's more than the Obama budget!

[update, 05-27-09:]
In a rather belated response to Sen. Bachus's concern that Wall Street banks might use PPIP to offload exposure onto the taxpayer while keeping the assets, FDIC Chair Sheila Bair (according to Bloomberg) said at a news briefing today that banks will not be allowed to bid on their own assets. JPMorgan Chase & Co. and Bank of America Corp. are among the banks yearning to do just that. Left unanswered was the question as to whether banks can buy assets from other banks. I wouldn't put it past the robber barons to devise paired transactions solely to mark up their inventory--I'll overpay for yours, you overpay for mine, quid pro quo. A suddenly suspicious Congress has added to the legislation authorizing PPIP
an amendment imposing conflict-of-interest rules and demanding that purchases of toxic securities be arms-length transactions.

[update, 06-03-09:]
The FDIC has placed its Legacy Loan Program on hold. In a statement today, Chair Bair said:
"Banks have been able to raise capital without having to sell bad assets through the LLP, which reflects renewed investor confidence in our banking system. As a consequence, banks and their supervisors will take additional time to assess the magnitude and timing of troubled assets sales as part of our larger efforts to strengthen the banking sector."

Mama Bair