Posts filed under “BP Cafe”
The Credit Crisis and Cycle Proof Regulation1
1 Remarks delivered by Raghuram G. Rajan, Eric Gleacher Distinguished Service Professor of Finance at the Homer Jones Lecture organized by the Federal Reserve Bank of St Louis in St Louis on April 15, 2009. I thank Luigi Zingales for very useful discussion including some of the ideas in this talk. All errors are mine.
The 2009 Homer Jones Lecture
by Raghuram Rajan
Eric J . Gleacher Distinguished Service Professor of Finance,
University of Chicago Booth School of Business
Federal Reserve Bank of St. Louis
April 15, 2009
We are currently engaged in a search for the causes of the current financial disaster. But in
pinning the disaster on specific agents, we could miss the cause that links them al. I will argue that this common cause is cyclical euphoria, and unless we recognize this, our regulatory efforts are likely to fall far short of preventing the next crisis.
But let me start at the beginning. There is some consensus that the proximate causes of the crisis are: (i) the U.S. financial sector misallocated resources to real estate, financed through the issuance of exotic new financial instruments; (ii) a significant portion of these instruments found their way, directly or indirectly, into commercial and investment bank balance sheets; (iii) these investments were largely financed with short-term debt. (iv) The mix was potent, and imploded starting in 2007. On these, there is broad agreement. But let us dig a little deeper.
This is a crisis born in some ways from previous financial crises. A wave of crises swept
through the emerging markets in the late 1990’s: East Asian economies collapsed, Russia
defaulted, and Argentina, Brazil, and Turkey faced severe stress.
In response to these problems, emerging markets became far more circumspect about borrowing from abroad to finance domestic demand. Instead, their corporations, governments, and households cut back on investment and reduced consumption.
Here is our latest comment FYI. Barry is wandering the wilds of Michigan and will be back soon with lots of channel observations. Chris
April 23, 2009
“What’s right about America is that although we have a mess of problems, we have great capacity – intellect and resources – to do some thing about them.”Henry Ford II
(1917 – 1987)
First, next Thursday, April 30, 2009, we will be participating in an important event in Philadelphia, “The Financial System, Banks & Economy: After the Storm…Where Are We Now?” The morning program includes Barry Ritholtz of Fusion IQ, David Kotok and Bob Eisenbeis of Cumberland Advisers, William Poole of CATO Institute and Diane Swonk of Mesirow Financial. For more information or to register, please click here: http://www.interdependence.org/Event-04-30-09.php
Next, we wish to thank the FDIC for the quick response to our last comment (“Can Citigroup Be Restructured Without an FDIC Resolution?”), where we suggested that the public record of the US banking industry is incomplete. We revised same to reflect their views. Bottom line is that the FDIC is presenting the bank unit data gathered from insured depository institutions correctly and consistent with GAAP.
Trouble is, while the current methodology may be precisely correct in a compliance and GAAP sense as it applies to federally insured legal entities, in our view and from a portfolio perspective, the FDIC dataset still is missing significant historic loss data, not just in 2008 but in previous years. Part of this situation stems from the “survivor bias” in the data. More, the impact of the timing of certain transactions and the use of GAAP purchase accounting has created some seemingly significant anomalies in both the historic record of the industry’s loss experience and in how GAAP accounting creates hidden reserves for acquirers, reserves that largely are invisible to retail investors but seemingly create distortions in reported earnings.
One reason that we took the risk of pissing off our friends at the FDIC by persisting with questions about the accounting treatment of the purchase of Wachovia Bank by Wells Fargo (NYSE:WFC), for example, is not only because the Q4 2008 industry data does not, in fact, include the charge-offs from Wachovia, realized losses that total into the tens of billions dollars. No, we were also interested in understanding how WFC got a little side benefit – a “cookie jar” in earnings terms – that is an effective subsidy for WFC to help absorb the cost of remediating the Wachovia portfolio.
Jonathan Weil of Bloomberg News wrote a very good analysis of WFC that puts the size of the cookie jar at $7.5 billion: http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a6sv0hG.nW7g
For those not familiar with the cookie jar concept, we turn back the pages of the proverbial comic book to pre-2004, when Sanford I. Weill was the King of the Citi and the folks at the SEC were sound asleep when it came to hidden reserves. During Sandy’s shopping spree to build the great financial bodega now know as Citigroup, Weill accumulated a number of acquisitions and, thanks to the benefits of good legal advice and purchase accounting, was able to amass a considerable, undisclosed reserve position.
Good Evening: After spending most of Earth Day solidly and appropriately in the green, stocks returned to Terra Firma late in the session. Various earnings reports and some conflicting stories about the current state of U.S. home prices all contributed to the crosscurrents that ruled Wednesday’s trading. It’s still too soon to say if “countertrend…Read More
Gary Weiss of Portfolio has just published a profile of Treasury Secretary Tim Geithner: http://www.portfolio.com/executives/2009/04/22/Treasury-Chief-Tim-Geithner-Profile He recalls my first experience with Geithner at an NYU conference on risk management hosted by the Stern School several years ago. Even though Geithner admitted yesterday in his congressional testimony that he has no actual financial markets experience whatsoever,…Read More
Testimony Before the Joint Economic Committee United States Congress Thomas M. Hoenig President and Chief Executive Officer Federal Reserve Bank of Kansas City Washington, D.C. April 21, 2009 2 Madam Chair Maloney, Vice Chair Schumer, ranking members Brady and Brownback, and members of the committee. Thank you for the opportunity to testify at this hearing….Read More
Good Evening: While many investors felt stressed yesterday about the upcoming release of our government’s attempts to test bank balance sheets under various economic scenarios, today appeared to be an official attempt to mollify those worries. And it worked — somewhat. Treasury Secretary Geithner and Fed Vice Chair Kohn offered enough soothing words that our…Read More
Kevin Lane is one of the founding partners of Fusion Analytics, and is the firm’s director of Quantitative Research. He is the main architect for developing their proprietary stock selection models and trading algorithms. Prior to joining Fusion Analytics, Mr. Lane enjoyed success as the Chief Market Strategist for several sell side institutional brokerage firms….Read More
The ‘Green Shoots’ of recovery that has been the favorite two words of many of late has been mostly predicated on the dramatic drop seen in inventories over the past few months and the subsequent inventory replenishment process that may help to stabilize the economy. The CEO of TXN in last nights earnings press release…Read More
I highlighted the short-term overbought nature of the stock market in my “Words from the Wise” review two days ago, saying:
- “From a technical perspective, a primary bear market still exists as long as the major indices remain below the January highs and the 200-day moving averages. Many of the rally’s leaders (indices and sectors) seem to be running into major resistance at these levels and look susceptible to retrace at least a portion of the gains since the March low. Further evidence of a short-term top in the making comes from a chart showing the percentage of S&P 500 stocks [90%] trading above their 50-day moving averages.”
Not surprisingly, investors’ lingering worries about the financial sector resurfaced yesterday, pulling the S&P 500 Index down by 4.3% and the Dow Jones Industrial Average by 3.6% – the worst losses since early March and in all likelihood a so-called 90% down-day.
While the short-term movements play themselves out, it is important to remember that the longer-term charts have not yet signalled a secular uptrend. Using monthly data, the graph below shows the multi-year trend of the S&P 500 Index (green line) together with a simple 12-month rate of change (or momentum) indicator (red line). Although monthly indicators are of little help when it comes to market timing, they do come in handy for defining the primary trend. An ROC line below zero depicts bear trends as experienced in 1990, 1994, 2000 to 2003, and again since December 2007. Having said that, the level of the indicator is grossly oversold, as confirmed by the RSI indicator (blue line).
Good Evening; In what could described as a less than fairly tale ending, the six week rally in both financial shares and the U.S. stock market came to a halt today. Another dose of economic reality didn’t help, but it seemed that the proximate causes were some so-called “earnings” from Bank of America and a less than flattering…Read More