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

Given today’s news release:

I’d like to direct your attention to an in-depth, three-part series on the troubled community banking industry by the Star Tribune newspaper in Minnesota.

Here’s a link to the project:

The paper has gotten very positive reaction to (brace yourself) their investigative journalism. The state Legislature is holding hearings on banking regulation in Minnesota as a result: State Senate plans hearings on banking regulation.

Here are links to the main stories:

Part 1: Minnesota’s small banks on the brink

http://www.startribune.com/business/51701012.html

Part 2: Credit unions: where the credit flowed too freely

http://www.startribune.com/business/51633817.html

Part 3: As loans grew, regulators shrank

http://www.startribune.com/51826122.html

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Click for bigger chart

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Sources:
State Senate plans hearings on banking regulation
State lawmakers will explore limiting real estate lending or beefing up the Commerce Department regulation staff
CHRIS SERRES,
Star Tribune, July 29, 2009 – 8:49 PM

http://www.startribune.com/politics/state/51999472.html

How’s your bank doing?

http://ww2.startribune.com/projects/maps/mnbanks/banks_keydata.html?elr=KArks:DCiU1OiP:DiiUiacyKUUr

VIDEO

Lenders Gone Wild: Part One

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Lenders Gone Wild: Part Two

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Lenders Gone Wild: Part Three

The FOMC statement was little changed relative to the August meeting. The data “suggests that economic activity has picked up following its severe downturn. Conditions in financial markets have improved further, and activity in the housing sector has increased.” They follow with the caveats of strained household spending due to “ongoing job losses, sluggish income growth, lower housing wealth, and tight credit” and also cutbacks in business investment but companies “continue to make progress in bringing inventory stocks into better alignment with sales.” They remain very sanguine on inflation as they believe the output gap will keep a lid on price pressures and they left out comments about the rise in commodity prices. Very dovish in my opinion and why the $ is at the lows. They will stretch out the buying of MBS/agency debt into Q1 ’10 and will end the purchases of treasuries in Oct. Net-net, a non event.

The best of explanation of the rally in stocks to a non event FOMC statement is that the Fed basically reiterated that money will be easy at a continued “exceptionally low” level for an “extended period.” They also backed this up with their very comfortable view that “inflation will remain subdued for some time” and didn’t even mention commodity prices as they did in August. Easy money has been a main backdrop and influence in the capital markets recovery since the March lows and the FOMC gave the green light for that to continue. “Ben’s World, Party Time, Excellent,” “Party on Wayne, Party on Garth!”

David Rosenberg is a 20 year veteran of the Street, David most recently was Merrill Lynch’s chief North American Economist, where he correctly warned about the Housing and Credit Collapse and Recession in advance. He is the Chief Economist of Canada’s Gluskin Sheff

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The Weekend Journal ran with an article by James Grant, which admittedly took
us by surprise (he is a true giant in the industry, as an aside) — From Bear to Bull
and in the article, he relies mostly on the thought process from two economic
think-tanks — Michael Darda from MKM Partners and the folks over at the
Economic Cycle Research Institute.

We highly recommend this article for everyone to read to understand the other
side of the debate. But we have some major problems with the points being
made.

1. Mr. Grant starts off by saying that “as if they really knew, leading economists
predict that recovery from our Great Recession will be plodding, gray and
jobless.” Well, frankly, it doesn’t really matter what “leading economists” are
saying because Mr. Market has already moved to the bullish side of the
debate having expanded valuation metrics to a point that is consistent with
4% real GDP growth and a doubling in earnings, to $83 EPS, which even the
consensus does not expect to see until we are into 2012. We are more than
fully priced as it is for mid-cycle earnings.

2. Nowhere in Mr. Grant’s synopsis do the words “deleveraging” or “credit
contraction” show up. Yet, this is the cornerstone of the bearish
viewpoint. Attitudes towards homeownership, discretionary spending
and credit have changed, and the change is secular, not merely cyclical.
After all, didn’t consumers just see a record $20 billion of outstanding
credit evaporate in August?

3. Mr. Grant emphasizes (the Darda argument) how we had a huge bounce in
the economy after the worst point of the Great Depression (in fact, the
subtitle of the article contains: “The deeper the slump, the zippier the
recovery”). Well, we didn’t have the Great Depression this time around —
real GDP did not contract 25% but rather by 3.7%. We probably have to go
now and redefine what a massive slump is. But all we had in the mid-part
of the 1930s — between the worst point in 1932 to the 1937-38 relapse —
was a statistical recovery, and nothing more than that. Nobody from that
era will recall that any year was particularly good — each one was just
different shades of pain and sacrifice. By the end of the decade, the
unemployment rate was still 15%, the CPI was deflating at a 2% annual
rate and the level of nominal GDP, as well as industrial production, still
had yet to re-attain its 1929 peak. The equity market in 1941 was no
higher than it was in 1933 (and long bond yields were heading below 2%)
and even a child knows that it was WWII that brought the economy out of
its malaise, not the seven years of New Deal stimulus.

So, to concentrate on the wiggles in the GDP data in the 1930s, no
matter how large, totally misses the point about what the decade was
really about, which was social change, a focus on family, less
discretionary spending, and a trend towards frugality that few market
pundits seem to comprehend. But the 1930s were the antithesis of the
1920s — not unlike what we are witnessing today. To concentrate on a
bungee jump that wasn’t even sustained is akin to focusing on the noise
around the trend-line as opposed to the trend-line itself.

4. The very sexy argument about how all the government stimulus is going
to give the economy a really big lift — combined monetary and fiscal
measures are worth 19.5% of GDP. This is viewed as a good thing, of
course, but nowhere in the analysis is there a comment about how this
“stimulus” is just there to cushion the blow and smooth the transition as
wide swaths of private sector credit vanish. We are at the point where
85% of housing activity is still being supported by government
interventions. Is this really desirable? According to BusinessWeek, it’s
not just the FHA financing 40% of new mortgage originations but the
USDA is also allowing builders and lenders to take advantage of rural
mortgages that require no-money down and with 100% financing
through “a little-known loan program”.

Well, as with most bulls, this new era of state capitalism is a reason to
rejoice. But from our lens, what would be more noteworthy would be an
article explaining that the massive government incursion with all this
“stimulus” is actually more a reason to be concerned than be jubilant —
what it really symbolizes is an economy that is so sick that it continues to
require massive doses of medication.

It’s not what all the stimulus does that matters — of course, it is there to act as a
cushion — but it is what all the stimulus has come to symbolize. A fundamentally
weak economic backdrop and a precarious banking system that has government
guarantees to thank for its survival.

We noted last week that the Nikkei posted six 20%+ rallies since its bubble
burst in 1990 and no fewer than four 50%+ rallies. Indeed, you can count
423,000 rally points from all the up-days since the secular bear market began in
1990 and yet the index is down 74% since that time. So actually, there is
nothing in this flashy move off the lows in the S&P 500 that is inconsistent with
a pattern of a bear market rally — this is not the onset of a whole new
sustainable bull market. These are rallies than can only be rented, not owned,
and are purely technically-motivated and momentum-driven. They are not
premised on improved fundamentals, despite data that are skewed to the
upside by rampant government intervention. Just remember, nobody ever built
more bridges or paved more river beds to skew the economic data than the
Liberal Democratic Party (LDP) did in Japan for much of the 1990s.

I will be winging back from Chicago as the Fed releases their statement, but I am going to go out on a limb and assume they will say something to the effect of this:

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Simple chart from David Rosenberg of Gluskin Sheff showing the 10 year returns by asset classes:

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If you believe in mean reversion over the long term — and this is a 10 year chart — then you probably are cautious on Gold here and more constructive on equities for the next 10 years.

The following is a guest post from a market strategist at a major research firm . . .

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The dollar rallied, did it? That was the “cause” of yesterday’s weakness in the energy and metals commodities, which in turn “caused” the related equities to sell off? Hogwash! Stocks are calling the tune here, folks.

The bond market may have preoccupied U.S. Presidents and Federal Reserve governors in the Eighties, and indeed the threat of higher interest rates always hangs over the stock market like the Damoclean Sword, but today’s policymakers have targeted stocks and spreads (they haven’t had to worry about interest rates since the Asian crisis in the late ‘90’s shocked the Asians into pursuing mercantilist trade policies that require large scale, price insensitive buying of U.S. debt).

If traders flipping E-mini S&P 500 futures are watching the DXY (the Dollar Index) or the EUR/USD cross for clues about risk appetites, then yes, on a day to day basis we can say that a stronger dollar may have “caused” equities to weaken. You can trust, however, that traders flipping DXY futures or euros are taking their cues from the stock market and that as often as the dollar moves the stock market, the stock market moves the dollar (specifically, “the dollar” as it is traded real time against other currencies, commodities, and assets).

We’re not watching one phenomenon (either a weakening dollar, or a rising stock market) occur, and then judging how that phenomenon will affect other markets, we’re watching all markets react in lockstep to policy.

Here’s an easy example: the Federal Reserve Bank of New York bails out AIG by taking its assets onto its balance sheet in exchange for loans and lines of credit. Anyone with a dollar bill in their pocket assumes a tiny bit of AIG’s risk (the Fed’s liabilities are dollars, don’t forget), and, assuming that AIG had to be rescued because its losses made it insolvent, anyone with a dollar bill in their pocket has a dollar bill that is worth a little bit less than it was prior to the bailout. This policy action therefore weakens the U.S. Dollar. Simultaneously, AIG’s creditors, which would have faced massive losses themselves, no longer face these losses. Their share prices rise because they are suddenly worth more. This policy action therefore supports the stock market.

This “policy ethos” has been in place since “the troubles” began in 2007. In conclusion, did the dollar rally “cause” weakness in the stock market yesterday? Possibly. But, does it make more sense to say that ongoing belief in the continuance of a “weaken the dollar, strengthen the stock market, shrink all risk premia” policy ethos ebbed briefly yesterday while from a weekly or monthly perspective it continues to flow? In my humble opinion, definitely.

If you want to know why this policy ethos has been chosen, look no further than the second quarter Flow of Funds report. Of all the frankly frightening, Frankenstein-ian data contained in the FoF (summarized by Doug Noland here), the financial media was buzzing about the $2 trillion rise in household net worth in Q2, the first such rise since 3Q07 (how ironic that the Federal government borrowed at a nearly $2 trillion
annualized pace in Q2!).

Stock market up, household net worth up, confidence in spite of falling wages and rising unemployment up, debt-fueled consumption up, and voila! It’s 2006 again. Or, look no further than yesterday’s comment from Lennar CEO Scott Shipley: “The sense that now is the time to buy is starting to gain momentum as potential qualified purchasers are getting confirmation from news reports and the overall stock market that prices are at or near lows.”

Take an image of Federal Reserve Chairman Ben Bernanke silently wiping a single tear of joy from his cheek as that comment scrolled across his Bloomberg terminal. Too bad about the dollar, though, right? (source: Bloomberg; Federal Reserve; Federated Investors)

Eric Kolchinsky, a former debt analyst for Moody’s Investors Service, says the firm gave “a high rating to a complicated debt security in January 2009 knowing that it was planning to downgrade assets that backed the securities.”

The WSJ reported that the securities were put on review for a downgrade shortly thereafter.

Excerpt:

“Moody’s issued an opinion which was known to be wrong,” Mr. Kolchinsky wrote in a July letter to the rating firm’s chief compliance officer, a copy of which was reviewed by The Wall Street Journal. In the letter, Mr. Kolchinsky cited other instances in which he believes inflated ratings were given to securities . . .

Before he resigned, Mr. Kolchinsky was a managing director in a nonratings unit and wasn’t involved in ratings of the securities in question. He was previously a Moody’s ratings analyst for six years and had experience with complex securities . . .

Between 2000 and 2007, Mr. Kolchinsky worked in the ratings group, rising to oversee credit ratings of mortgage-linked securities known as collateralized debt obligations, some of the hardest-hit investments during the credit crisis. Mr. Kolchinsky said he feels “some moral responsibility for the poor CDO ratings” issued under his watch.”

Kolchinsky is scheduled to testify tomorrow on ratings-firm reform before the House Committee on Oversight and Government Reform. Should be some giggles watching Moody’s, S&P and Fitch’s lawyers during his testimony.

My solution is to remove the special NRSRO status for the 3 firms, open ratings up to competition, and eliminate the newer “payola” model — having underwriters pay for ratings instead of debt buyers.

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Source:
Congress Takes On Credit Ratings
SERENA NG and AARON LUCCHETTI
WSJ, SEPTEMBER 23, 2009

http://online.wsj.com/article/SB125366267173132295.html

The MBA said the average 30 yr mortgage rate for the week ended Friday fell below 5% for the first time since late May, at 4.97%. In response, refi’s rose 17.4%, the highest since May while purchases were up 5.6%. This news comes as the FOMC discusses the fate of their purchases of MBS/Agency debt and Treasuries. They will reiterate that the buying of Treasuries will end in Oct as they are just about done with the $300b plan. The buying of MBS and agency debt will likely continue until year end. As of Sept 16th, they have purchased a combined $810b of the $1.45t that is planned. Combining low rates, cheaper homes and the home buying tax credit, housing in certain areas has caught a bid so the question of course is what happens when the Fed is done buying MBS and whether the tax credit gets extended past Nov 30th. ABC confidence rose 3 points to -46. The Euro Zone manufacturing and services index rose a touch to 50.8 but was .5 point less than expected.