The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

I did a few minutes of schtick on NPR yesterday about nationalizing the banks:

click for audio

>

>

Source:
Banking On Nationalization
Madeleine Brand
NPR Day to Day, February 25, 2009

http://www.npr.org/templates/story/story.php?storyId=101144619

~~~

I am on the road so I haven’t had a chance to fully detail our views or reflect on them relative to the equities. That said, here are quick initial thoughts on the stress test and CAP:

The underlying macro-economic assumptions of the stress test are not terribly “stressed”. They are more probable than unlikely:

* 0.5% GDP growth in 2010, after -3.3% in 2009 is now looking quite realistic

* 10.3% unemployment rates in 2010, after 8.9% in 2009. We have estimated, if government stability plans fail, the rate will rise to 11% in 2010)

* 7% declines in home prices in 2010, 22% in 2009 (They are down 18.8% y/y and 27% since 2006 peak, we have estimated a 2011 trough. Long term trends in home prices suggest that we will revert close to the peak levels of the previous cycle)

As a result, our initial expectation is that this will not be the last stress-test we run nor the last capital plan. This CAP plan will, like the other plans before, not resolve the problems with troubled banks. Instead, it will result in ultimately larger losses, larger Treasury issuance, larger deficits and several more weak and anticompetitive banks.

The terms on this also raise questions. I highlight two, as example.

- “Convertible in whole or from time to time in part at the Conversion Price at the option of the QFI at any time, subject to the approval of the QFI’s primary Federal banking agency.” – The investor doesn’t control the conversion, the issuer does! What kind of convert is that?

- “Notwithstanding the foregoing, if applicable, the dividend rate on the Convertible Preferred shall increase to 20% per annum on the sixth month anniversary of the issue date of the Convertible Preferred if the consent of the QFI stockholders described below has not been received by such date, and shall remain at such level until the date on which such stockholder approval is received.” – Is a contract under duress legal? It sounds like it is essentially saying “if you don’t have enough shares out to allow conversion we will charge you 20% until shareholders approve shares for their own dilution”.

- Nowhere does the plan define whether they will fill the capital hole in entirety or not nor does it define how the stress test will flow through to the banks capital needs.

- There are key capital valuation assumptions that are missing from the plan. How does a black box macro model flow through to the loss estimates? Ironically it seems we are continuing down the path that drove me to label this failed era in financial services – beginning to end – as “when models failed”.

They’ll almost certainly come back in 6 months or so for a third round run of this. In the meantime consider that last years Treasury net issuance of about $350 billion could increase above expectations of about $1.5 trillion to perhaps $2.2 or $2.3 trillion. It is enough to expect China, Japan and others to continue to purchase our debt. Will they quadruple or quintuple their purchases? What would happen if we had an undersubscribed auction? How long could we have a straw buyer bidding? What would happen to inflation expectations?

We have a viable banking system of 8500 banks. The argument that the top banks are the entirety our system of intermediation is not true, especially given the lack of capital market activity they drove through syndication, securitization and offerings. Let’s get on with it. Wipe out the bad banks today before we have to wipe out depleted government equity in those banks tomorrow. Body parts of the dead could provide life to the wounded.

Some very ugly data today on New one-family house sales for January 2009.

The seasonally adjusted annual rate of 309,000 — a record-low. (The December data was revised downwards to 344,000 unit sales).

The month over month data at down 10.2% was not statistically significant given the margin of error of ±15.4%.  The year over year data is an astonishing contraction of 48.2% (±6.8%) below January 2008′s 597,000 sales. Approximately 342,000 new houses for sale at the end of January, representing a 13.3 month supply.

Median price fell 13.5% year over year, and dropped 10% sequentially (monthly).

Rex Nutting adds that the drop in January took place “despite a record drop in prices.”

>

via Barron’s Econoday

>

Source:
NEW RESIDENTIAL SALES IN JANUARY 2009
U.S. Census Bureau and the Department of Housing and Urban Development.
February 26, 2009

http://www.census.gov/const/newressales.pdf

Economist James Galbraith, who’s scheduled to testify in Washington Thursday, talks to MarketWatch’s Ruth Mantell about the future of the U.S. banking system and what the Federal Reserve can, and can’t, do help shore up the economy.

4:15
Marketwatch, 2/25/2009

Via NYT

Source:
Big Drug Makers May Seek to Fill Holes in Roster
NATASHA SINGER and DUFF WILSON
NYT, February 24, 2009

http://www.nytimes.com/2009/02/25/business/25place.html

January Durable Goods fell a greater than expected 5.2% (consensus was -2.5%) but ex transports, the drop of 2.5% wasn’t that much worse than estimates.

However, the December data was revised down sharply. Non Defense Capital Goods ex Aircraft fell a sharp 5.4% after a 5.8% drop in Dec. The declines were widespread and further evidence of companies continuing to batten down the hatchets. Shipments, which gets directly plugged into GDP, fell 3.7% and is down for 4 straight months.

The inventory to shipments ratio rose to the highest level since 1992. Initial claims totaled 667k, much higher than the consensus of 625k and Continuing Claims were 87k more than expected and at a new all time high (but not adjusted for population growth) and does not bode well for next week’s employment data.

Bottom line, there is absolutely nothing within today’s data to hang one’s hat on as the deterioration continues and the dark tunnel sees no end.

– Peter Boockvaar

While the word nationalization seems to be terrifying many observers, another technical financial term is gaining acceptability: Zombie Banks.

NYT columnist Paul Krugman used the term in a recent column; Fed Chair Ben Bernanke said in Congressional testimony that there was “no such thing as a US zombie bank.” The term even has its own wikipedia entry.

Why are even discussing what sounds like a b-grade horror flick? What is a Zombie bank?

A Zombie Bank is a financial institution whose liabilities outweighs it assets, making its net worth “less than zero.” ZBs continue to operate because of the implicit or explicit government guarantee — along with truckloads of taxpayer monies.

Consider the two biggest Zombie banks — Citigroup, and Bank of America.They have each received $45 billion in capital from the US government — far more than either bank is worth. Additionally, the US had guaranteed up to 90% of the bad assets each zombie is holding — $250 billion and $306 billion respectively.

The term comes from Japan’s lost decade following their real estate bubble. The Japanese kept their zombie banks alive, delaying the eventual recovery by a decade.

The reason I favor nationalization is that I hope we here in the US avoid a lost Japan-like decade from September 08 forward. Keeping these banks propped up with more and more taxpayer monies — the Obama Administration has proposed another $750 billion more in bank-rescue aid — is not the way out of this mess.

Curse of the Zombies

via WSJ Marketbeat

>

Previously:
The New N Word: Nationalization (February 25th, 2009)

http://www.ritholtz.com/blog/2009/02/nationalization-the-new-n-word/

Sources:
Curse of the Zombie Banks Haunts Fed
Mark Gongloff
WSJ, FEBRUARY 26, 2009

http://online.wsj.com/article/SB123560389732776681.html

There are no zombie banks, Bernanke says
Greg Robb
MarketWatchLast update: 4:05 p.m. EST Feb. 24, 2009

http://tinyurl.com/zombiefed

Zombies Must Die
Jeff Matthews
Jeff Matthews Is Not Making This Up, February 25, 2009

http://jeffmatthewsisnotmakingthisup.blogspot.com/2009/02/zombies-must-die.html

Obama’s Budget Proposes Up to $750 Billion More Bank-Rescue Aid
Roger Runningen and Brian Faler
Bloomberg, Feb. 26 2009

http://www.bloomberg.com/apps/news?pid=20601087&sid=aY8vuevw1NKs&

Zombie Banks Feed Off Bailout Money
Chris Arnold
NPR, February 17, 2009

http://www.npr.org/templates/story/story.php?storyId=100762999

Supervisory Capital Assessment Program

Source:
FAQs – Supervisory Capital Assessment Program

http://www.fdic.gov/news/news/press/2009/pr09025a.pdf

In his first address to a joint session of Congress last night, President Obama called for expensive and broad efforts in three major areas — energy, health care and education. He also suggested government bailouts are far from over.

In short, Obama outlined a broad, ambitious overhaul of domestic policy after eight years under President George W. Bush. Will the blueprint work?

Our guest Joe Brusuelas, director of market economics for Moody’s Economy.com, so far likes what he has heard, saying now is the time for decisive leadership on spending issues. And that’s a compliment coming from Brusuelas, who publicly had supported Senator John McCain.

Good Evening: Hopeful during his campaign and dour since, President Obama used a national stage last night to resume his optimistic stance on America’s future. It’s as if his handlers finally decided to echo Ronald Reagan’s advisors to just “let Obama be Obama”. Our president tackled many subjects and promised many things, but he essentially punted on the subject of giving more detail about how to tackle the financial crisis. And, since President Obama’s audacious spending plans didn’t seem to square with his promise to “cut the deficit in half” in four short years, investors spent much of Wednesday brooding about what might come next.

Stock index futures didn’t have much reaction overnight to Mr. Obama’s address, and they were pointing to a modestly lower open prior to the release of today’s economic data. Mortgage purchase applications once again fell and now sit very close to the lows of this cycle. Reinforcing the message that housing still remains a sore spot in our economy, existing home sales also slumped while inventories increased. Since this horrible sales figure was actually flattered by a spate of foreclosure sales, the picture of demand for U.S. housing remains a grim one. On a positive note, however, Fed Chairman Bernanke did offer a little more insight into the administration’s plan to have banks undergo a “stress test” (for BAC-MER’s take, see below). Mr. Bernanke backed even further away from what Barry Ritholtz calls the new “N word” (Nationalization), but even his explanation about the stress tests our banks will soon undergo lacked enough detail for investors to feel an emerging sense of clarity.

What emerged after the opening bell rang at the NYSE was a decline in stock prices. Though the major averages never did give back all of yesterday’s gains, they were sacked for a 3% loss less than two hours into the session. Mr. Bernanke’s testimony before the House did seem to help prices recover at mid day, but disappointment over the President’s missed chance to announce a sweeping approach to the credit crisis exerted a gravitational pull on equities by day’s end. Despite strength in both bank stocks and tech stocks, the major averages fell between 1.1% (S&P 500) and 4% (Dow Transports). Treasury market participants were none too happy with all the new spending outlined by President Obama last night and prices across the entire spectrum of fixed income declined today. For its part, the dollar was less concerned about deficits in the U.S. as it was about potentially even larger ones looming in Europe. The dollar index advanced 1.25%, while commodities ignored every other market and rose. Another gain in the energy and grain complexes more than offset another weak day for precious metals as the CRB index rose more than 2%.

Back when he was just a candidate for the U.S. Senate, Barack Obama was invited to give the keynote speech for the Democratic national convention. Entitled, “The Audacity of Hope”, this optimistic piece of oratory made Mr. Obama famous and helped catapult him not only into the Senate but into the national spotlight. In 2006, then Senator Obama released a book by the same title and it set the tone for a campaign that eventually landed him in the most powerful office on earth. His speech last night before a joint session of Congress was no less bold and optimistic. Investors wanted him to unveil a comprehensive plan for addressing our nation’s financial woes, but this topic was covered only in general before our President moved on to his real agenda.

Expanding upon some of the themes touched on in his book, Mr. Obama asked Americans to back his vision to help the banks, promote clean energy technologies, reform education, and completely transform the health care system. Our audaciously hopeful president even promised, presumably once these first four issues are dealt with, to touch the third rail of politics in offering to also reform Social Security. Oh, and did I mention that President Obama also stated a clear goal to “cut our deficit in half” during his first term? I guess that writing trillion dollar checks to help our banks and our economy must make programs costing “only” in the hundreds of billions (each!) to look downright cheap by comparison.

When Ronald Reagan was swept into office in 1980, he also promised bold reform while cutting the deficit. Unfortunately, the numbers never did add up properly and our nation has spent far too much time in the red ever since. Now President Obama wants us to embark on plans that amount to the New Deal and the Great Society rolled up into one? I have no problem with short run deficit spending during an economic collapse, but there is no way in HE double toothpicks our nation’s deficit will be halved. It will likely explode. Could this vision of an endless supply of Treasury auctions be one of the reasons the bond market fell today despite a weak stock market? Perhaps I’m missing something, and perhaps my arithmetic is a little rusty. Maybe Mr. Obama really has found $2 trillion in “wasteful spending” (like the $800 billion stimulus bill?) to pay for all these new programs. I truly hope his foresight is 20-20, but I will continue to hold my gold and precious metals mining stocks just in case. The audacity of hope? Though it’s better than pessimism, this form of hope is audacious indeed.

– Jack McHugh

U.S. Stocks Retreat as Insurers Cut Dividends, Home Sales Drop

Obama Casts Crisis as Chance to Overhaul Banking, Health Care

U.S. Sets a 6-Month Deadline for New Bank Capital

Economics of the CAP stress te.pdf