Friday, January 30, 2009

3 on a Match: FDIC Closes More Banks

Three more banks were closed by the FDIC today, all of which were at the top of our bad banks list. Oddly, the FDIC did not release a loss estimate for MagnetBank.

The trend of high FDIC losses relative to bank assets continues......and the FDIC wants to manage the bad bank !!????!??!???!

They failed at regulating and monitoring banks, modified IndyMac loans are defaulting just as quickly as the original loans, the insurance fund is under $40 billion and they want more responsibility?

U.S. Economy is Sinking...Quickly

The Advance GDP report was released today: adjusted for inflation, output decreased at an annualized rate of 3.8%. This is the largest quarterly drop in 26 years. This is the first estimate of fourth quarter growth, two more releases will follow with revised data.  It is possible that the final numbers will improve, but I am not holding out hope.

The graph below tracks U.S. Treasury Debt as a percentage of nominal (unadjusted for inflation) GDP. On 9/30/08 (the most recent date with finalized data), the ratio stood at 69.6%. This is the highest level in a generation. Preliminarily, using Treasury estimates and today's GDP report, the ratio is at 75%.

Thursday, January 29, 2009

Better Late Than Never: Economic Data Review

Several important economic reports were released today. They all had one thing in common: the economy is far from okay. This falling chain of dominoes has been set in motion by the real estate bubble.

New home sales have fallen off the proverbial cliff. Over supply and ever tightening credit standards are the culprits, the later being covered in previous posts regarding bank reserves.

Without robust new home sales, one would expect durable goods sales to suffer as well. As covered in an earlier post, durable goods are products such as appliances, home furnishings, electronic equipment, etc.

Without robust durable goods sales, one would expect job losses. Initial jobless claims have been rising and now stand at multi-year highs.

Continuing claims are rising as well. It is becoming increasingly difficult to find a job after termination.

Some members of the press corps have dismissed this data because the population has grown since the last time the U.S. experienced similar job losses. To those Pollyannas: the above graph lets us know that we have surpassed RELATIVE highs in the number of jobless claims as well

Meredith Whitney is on Board

“Simply removing ‘toxic’ assets from bank balance sheets will not directly cause banks to increase lending,” Whitney wrote in a note today.

The banks likely won’t participate in selling assets if the Obama administration wants to pay fair market value for the assets “as capital hits would be too dear,” Whitney said.

Experts Agree With Populus Vox

“We should not trust these bankers; look at their track record,” Taleb said. “They know we’re going to bail them out. They hold us as hostages” and “the only way to stop the process is for the government to own those banks, tell them what to do.”

My emphasis added in the quote.

Taleb also observes how our economy is capitalistic when private industry profitable, but socialistic when private industry is unprofitable.

Wednesday, January 28, 2009

"Bad Bank" Rally

Financials are ripping it up today because a "bad bank" solution to the market's troubles is in the offing. Well, before any declares the financial crisis over, I have a few questions:

- How will the bad bank price the assets? This was the problem with the TARP in the first place.

- Who is going to run the bank bank? Seems like the FDIC wants the job, although their restructuring efforts as of late are unimpressive.

- How will the bad bank pay for the assets? I am assuming the Treasury will issue debt.

- Will the sellers maintain any profit / loss potential from the disposed assets?

Tuesday, January 27, 2009

Cram Down Update

House panel approves legislation. Let the games begin.....

Monday, January 26, 2009

Volatile Day for Bank Stocks

KBW Bank Index traded up as much as 4% and traded down as much as 4.4%, finally closing down 3% for the session. A bearish report on the sector (they like JPM however) by Goldman Sachs was given credit for the trade-off.

The link below will take you to the Treasury Department website for a full list off TARP allocations.

Just the Tip of the Ice(land)berg...

"Iceland's Government Collapses"

Back on 11/17/08, I put up a post on the troubles in Iceland. Things have not improved, in fact most of Europe is in the midst of a very difficult period. The Euro is past its glory days and the bill needs to be paid.

Cram Down and Wide Mortgage Spreads

For over a year, there have been debates about the consideration of mortgage loans in bankruptcy filings. Traditionally, mortgage loans on a primary residence were not included in bankruptcy proceedings, i.e. the borrower could not get rid of the mortgage loan by declaring bankruptcy.

However, there have been indications that the government will allow bankruptcy court judges to modify mortgage loans. The term "cram down" refers to the power of the court to force loan principals lower. For instance, if a borrower owes $125,000 on a house that is now worth $100,000, the judge can cram down the loan by $25,000 (the loan floor is the property value) to facilitate payment.

Therefore, the risk to holders of mortgage loans and mortgage backed securities will increase substantially. In addition, second lien holders are especially vulnerable because the cram down will be applied to the secondary loans first.

Perhaps the below graphs highlight the concern bankers have about this issue (as well as continued defaults):

The above graph tracks fixed rate mortgage rates. Rates have fallen to new lows (moved higher last week), but that is only part of the story.

The above graph tracks the difference between the mortgage rate and the yield on the 10 year Treasury Note. The higher this spread, the more risk averse bankers are. They would rather use their TARP money to buy government debt than risk lending to prospective homeowners.

Some links for reference:

Wall Street Journal Catches up to Populus Vox

Lead article in today's Wall Street Journal:  Banks are NOT LENDING, holding on to TARP funds.  Of course, we have known that for weeks.  Back on 1/16/09 & 12/22/08 I posted reviews of the banking system excess reserves, which let all who read know that solvency was the main concern of the financial intermediaries.

Sunday, January 25, 2009

2009 Bank Failure #3

Chart on left is the bad bank list, chart on the right is a list of closed banks.

Yep, another one closed on Friday.

Saturday, January 24, 2009

Freddie Muck (Mac): Just When You Think It Can't Get Any Worse....

Freddie filed some paperwork with the SEC yesterday, highlighting how poorly their business is going.  Freddie Muck anticipates a need for a $30 billion - $35 billion capital injection in the near future.

The Muck also released a rundown of their portfolio and obligations that pretty much guarantee that the tax-payer is in trouble, big trouble:

$1.827 trillion in mortgage guarantees

$870 billion in debt

$3 trillion in mortgage and mortgage backed holdings

I have also read anecdotal stories about mislabeled loans and near fraudulent activity, but I can't confirm that.  I would not be surprised though.

Friday, January 23, 2009

Goodwill: Phony Asset

When reading about corporate acquisitions, we often discover that the acquiring company pays a premium over the stock market value to take over a company. This is done to entice the seller to pony up the entire company and avoid proxy fights and extended negotiations.

The peculiar thing is that, according to Generally Accepted Accounting Principles (GAAP), this results in an asset called goodwill on the books of the buyer. I guess the idea is that the buyer will realize synergistic benefits from the combination and should be more highly valued.

What happens if the acquisition stinks? Shouldn't this goodwill asset be written down? The answer is yes. Several companies have written down the value goodwill (an asset that does nothing) in the last few months:

Regions Financial (NYSE: RF) - $6 billion write down reported on 1/20/09

National City Corp. (NYSE: PNC) - $1.34 billion write down reported on 11/6/08. Nat City was acquired itself by PNC on, I think, 12/31/08.

Royal Bank of Scotland (NYSE: RBS) - estimated GBP 17.5 billion ($24.15 billion) for year end 2008. RBS is also expected to report a total loss of $41 billion for 2008, the largest loss in U.K. history.

With the current performance of the financial markets, it is hard to believe that goodwill is worth much of anything. writing it off, although not explicitly consuming cash, does delete capital. Capital is a scarce resource. Regulators have discussed liberalizing the valuation of this nonsense asset to stabilize banks and ease capital stress.

Based on numbers reported on 9/30/08 for banks with over $10 billion in assets:

- Goodwill accounted for 3.13% of total assets: $302.8 billion

- Equity capital accounted for 9.42% of total assets: $910.5 billion

So, 33.26% of capital is a phony asset. Will you sleep better tonight?

Please click below to expand.

Wednesday, January 21, 2009

GE Puts Active Again

Mar '09 $5.0 puts
60,807 contracts traded

Feb '09 $10.0 puts
44,157 contracts traded

Feb '09 $5.0 puts
38,262 contracts traded

stock closed @ $13.03

U.S. & U.K. Bank Stocks (those that are still around)

Click graphs to expand. Note: Relative price charts. For example: Citi has a most recent value of 11.48, meaning that it is trading at 11.48% of its price of 1 year ago.

A Buffet Bank Disappoints

U.S. Bancorp (NYSE: USB) posted 2nd quarter earnings of $0.15 per share versus a street estimate of $0.28 per share.

Warren Buffet holds large stake in Wells Fargo, U.S. Bancorp and M&T Bancorp.  All three had outperformed the industry through most of 2008.  However, the cracks started to show late in the year.  Wells Fargo was in the same business as Wachovia and Countrywide.  It made no sense that the market assumed that they had some magic formula that would allow them to escape the massive default wave that crushed the others.  The worsening commercial real estate market will continue to pummel U.S. Bancorp and will weigh on M&T.  Lesson here is: always do your own homework.

Equity futures are off their overnight highs:  pointing to a rise of 65 points for the Dow

Tuesday, January 20, 2009

Mounting Banking Issues

The forecast portion of the graph is based on a simple regression of lagged delinquencies. The entire system is dangerously close to insolvency.

More Proof: We (Tax-payers) Are Suckers

Please click the above chart to expand.

I know this chart is getting boring, but it speaks volumes. Once again, it tracks the amount of TARP funds certain companies have received (in return for 5% preferred stock) and the current market capitalization of those companies. The ratio is a gauge of how risky the government's bet (i.e. YOUR BET) is. The higher the ratio, the less likely WE are of getting our money back.

The market capitalization is the value at which the stock market is pricing the entire company. Sublime.

Bad Day on Wall Street

Well, well, well........ no bid for stocks today.  

The Dow Jones Industrial Average closed at 9,625.28 on 11/4/08.  Since then:

28 losing sessions
23 winning sessions

Loss of 1,676.19 points or 17.4%

The market seems to be coming around to my way of thinking, a new president is not the answer to our economic woes.

Unusual Put Volume: General Electric

The following put contracts traded in heavy volume today:

Feb '09 $7.5 puts
51,866 contracts

Feb '09 $10.0 puts
50,209 contracts

Feb '09 $5.0 puts
24,569 contracts

One possible explanation for this activity is that their earnings report on the 23rd will disappoint and the stock will crater.  Keep an eye on this one.

Sunday, January 18, 2009

Bank Troika USA Revisited

Bank of America Corporation (pro forma): $857.3 billion in domestic deposits

Wells Fargo & Company (pro forma): $721.7 billion in domestic deposits

JP Morgan Chase & Company: $712.3 billion in domestic deposits

Troika Total: $2.2913 trillion

Industry Total: $7.2220 trillion

Troika Market Share: 31.70%

I guess they can push the government around..........

Bank of America data includes banks acquired in Merrill Lynch deal.

Wells Fargo numbers include Wachovia.

Lyondell Chemical Compay: CDS Settlement

Back on 1/6/09, Lyondell filed for bankruptcy court protection. The CDS auction will be held on 2/3/09 to determine how much the CDS holders will receive. This is one of the 20 largest corporate bankruptcies in U.S. history.

More Bad News From Across The Pond

Speculation that the U.K. government will need to inject capital into more banks.

Fair Value For Equities

I last took a look at this in a post from 11/11/08. Since then, there have been some major changes in the financial sector, as well as the retail sector..........

Based on past peak to trough valuations, Standard & Poor's estimates and some good, old fashioned gut feeling:

Average trailing 12 month earnings for the S&P 500 for 2009: $38.63

Average earnings yield since 1988: 4.882%

38.63 / 4.882% = 791.11

A level of 791.11 on the S&P 500 roughly equates to a level of 7,534.36 for the Dow Jones Industrial Average. Currently, the indices are trading at 850.12 and 8,281.22 respectively.

This would imply a drop a continued drop of about 8% from current values. Quite simply, earnings yields are not high enough to buy stocks.

Is This The Direction in Which The U.S. is Heading?

Wow, the U.K. itself will supply funds to the borrowing public. I guess it is not a big stretch when you consider that the U.K. government owns 58% of the Royal Bank of Scotland and 30% of Lloyds TSB.

Recall my post from last week regarding the incredibly large number of reserves held in our banking system. The U.S. government is being forced to a corner: pony up funds or look like the bad guy.

Saturday, January 17, 2009

2009 & More Bank Failures

Please click on chart to expand.

Two more closed on Friday, further depleting the FDIC's insurance fund. To review, the fund was last reported to sport a reserve ratio of only 0.76%. That is, funds of $34.6 billion backing $4.54 trillion in deposits. Add to that the over $120 billion in corporate debt that the FDIC now insures (TLGP) and an estimated $230 million in losses caused by Friday's closures and you have a system in which THE TAXPAYER IS ESSENTIALLY INSURING THEIR OWN DEPOSITS. THE FDIC DOES NOT HAVE ENOUGH IN RESERVES, THE TAXPAYER WILL BE CALLED ON TO BACK THE FUND VIA TREASURY DEBT ISSUANCE. WE ARE BEING HAD.

Friday, January 16, 2009

.....While the Taxpayer Goes Bust

So the banks hoard reserves, essentially blackmailing the Federal government to get the taxpayer funds they want. Capital infusions & asset guarantees at the same time the Federal Reserve actually is PAYING A HIGHER RATE TO HOLD RESERVES than the market pays for deposits. We are being had here folks.........

The End of an Era: Citi no Longer a Group

Nice move by the Treasury Department.  $45 billion of taxpayer money into a company that is liquidating itself.  Citi's last posted positive earnings for the 3rd quarter of 2007.  Since then, 5 straight quarters of losses:  roughly $30 billion down the drain.

On top of this, Bank of America gets another $20 billion in capital (bringing the total to $45 billion including Merrill's funds) and $118 billion in asset guarantees.  I do NOT remember voting on this issue in November:  backstopping Ken Lewis' stupidity and arrogance.

If I didn't know any better, I'd say they were operating this poorly on purpose.

Thursday, January 15, 2009

Capital Adequacy Rumors

Click on chart to expand.

Rumors today about Citigroup either being on the brink of nationalization or takeover and Bank of America requesting $15 billion more in TARP funds.


7,995.13 print @ 12:39 PM

Closed @ 9,034.69 on 1/2/09

More & More Foreclosures

Home foreclosure filings for 2008 totaled 3.16 million. To put that in perspective, existing home sales are running at about a 4.4 million annual pace. The market is creeping up on a year's worth of sales in terms of possible foreclosures.

Also worth noting is the increase in foreclosures among prime (high credit ratings) borrowers. At a rate of 1.6% (foreclosures as a percentage of loans), the market has witnessed a 3 fold increase.

How does this cripple banks? Foreclosures and loan losses are obviously linked. Banks are typically leveraged $10 to $1, their assets are 10 times larger than their capital base. Assets are equal to the sum of liabilities and capital. When a loan (asset to the bank) is written off, assets are depleted and a corresponding adjustment needs to be made to either liabilities or capital. Just because a bank has trouble with its assets doesn't mean it gets a break on money it owes, so liabilities won't drop. Capital is decreased by the same amount as the loan write off. So, a bank (on average) can only survive a 10% failure rate on its assets until it sinks.

Wednesday, January 14, 2009

Dow Moves When January Is Down (Since 1984)


Whole Year

Whole Year



Total Return



































NorTel We Hardly Knew Ya

NorTel Networks filed for Chapter 11 bankruptcy protection today. You may remember this high-flyer from the Internet days.

Retail Sales Data

For the first time in 16 years, annualized retail sales fell. The report released today highlighted the weakness in the consumer sector: December, 2008 was the worst month since September, 2005. Although $4.48 trillion in retail sales for all off 2008 sounds great, the fact that the figure dropped ever so slightly from 2007's $4.49 trillion does not bode well for the consumer discretionary category. From Macy's closing stores to the bankruptcy of Linens 'n Things, Circuit City and today Gottschalk's, the commercial mortgage market will continue to incur losses. Following the dominoes, banks will continue to need capital.

Please note: Retail sales were 18.8% of GDP in 2002

Retail sales were 31.7% of GDP in 2007.

Tuesday, January 13, 2009

Liquidation Follow-Up

From a Bloomberg news story:

     Jan. 13 (Bloomberg) -- Hedge funds lost $350 billion
globally in 2008, the most on record, as the biggest financial
crisis since the Great Depression crippled returns and caused
investors to pull money out, according to an industry report.
     About 90 percent of the money was lost in the three months
to the end of November, according to a preliminary report
published today by Singapore-based data provider Eurekahedge Pte.
Funds that invested in North America declined the most, posting
a drop of $183 billion for the year, the report said.

In addition, pension funds suffered severe losses as well.

Is HSBC Being Targeted?

Unusual put (bet that stock will drop) volume yesterday:

-March, 2009 45 puts: 87,365 contracts traded
average daily volume excluding yesterday: 161 contracts

-March, 2009 50 puts: 51,378 contracts traded
Back on January 7th, 40,775 contracts traded
average daily volume excluding those 2 days: 192 contracts

It is hard to tell what exactly this means, it could be massive bearish activity or some type of capital markets hedging (equity offering, linked note, etc.).  This should be monitored for the next few sessions.

Much like other financial companies the stock (ADR) has been hammered:  closed @ $87.67 on 5/2/08, currently trading @ $46.70

Market Summary

Yesterday's markets smacked of one thing: Large Scale Liquidation

-Equity markets down

-Commodity markets down

-Treasury market up

-Volatility markets up

The end of 2008 was particularly hard hit by hedge fund redemptions.  As investors, sought to recapture funds, managers were forced to sell even performing assets to raise the necessary cash.  In addition, the funds weer forced to raise cash to meet margin calls.  This factor is still relevant.

Although there are some signs that interbank lending is recovering, corporate lending spreads are still very high.  I don;t think this will improve until we have some positive earnings reports.

Wednesday, January 7, 2009

Tribune CDS Settlement

For those of you playing at home, Tribune Co. (owner of the Chicago Tribune, Chicago Cubs, Wrigley Field and other assorted media assets) filed for bankruptcy protection back in December.

The settlement auction for CDS pricing was held yesterday:

23.75 cents on the dollar for loan-only CDS (CDS on secured, syndicated loans: less general than standard CDS)

Here is the zinger: 1.5 cents on the dollar for standard CDS.

98.5% loss on debt, some business that newspaper publishing is.  

Japanese Rating Agency Does Not Like Treasury Debt

Missed this on Christmas Eve. Please refer to the below post I made after reading above link:

Crowding Out

Crowding out: The U.S. government will be issuing billions upon billions of debt this year.  In addition, corporations of all types will also need to borrow.  Those with funds to invest have to make a decision regarding which bonds to purchase.  Should they buy bonds that are backed by the full taxing power of the federal government or a company that has seen its earnings fall 40% or more?  What additional yield will a prospective buyer require to purchase the riskier asset?

2009 Budget Update

I was way off: the Congressional Budget Office released an estimate of a $1.2 trillion deficit for 2009.

Of note, the CBO is including GSE costs into the budget.

Bad News on the Jobs Front

ADP National Employment Report estimates that the economy lost 693,000 jobs (non-farm, private employment) in the month of December. For 2008, they report a loss of 2,598,000 jobs.

Based on a simple regression, this points to a loss of 653,000 jobs according to the BLS survey. This report will be released on Friday.

Background: The Bureau of Labor Statistics reports the change in the number of non-farm payrolls on a monthly basis. This has been an important economic indicator, occasionally having the ability to dramatically move markets. A few years ago, Automatic Data Processing started their own survey. They use data from roughly 80% of their clients to create the report.

What Can President-Elect Obama Really Do?

As January 20th approaches, it seems appropriate to take stock of the situation in which the new President will find himself.  Efficacy aside (I for one never thought that Roosevelt's New Deal ended the Great Depression, WWII was the tide changer), fiscal policy will be pegged to the right side of the speedometer.  No one wants to raise taxes or decrease spending, so that leaves borrowing money to pay for the new policies.  The problem is, by virtually any benchmark, the USA is already levered to the hilt.  In addition, other developed nations are facing similar budget shortfalls (I will focus on the U.K.), providing competition for global funds.  

This pseudo command economy approach to solving market economy woes will not work.  The U.S. economy need wholesale restructuring, the type of which will no doubt be painful. However, delaying the inevitable by propping up zombie companies and dead-beat borrowers jeopardizes the ENTIRE monetary structure.

Let's take a look at the federal government's debt tally:

Total Public Debt Outstanding: $10.65 trillion
(Treasury Bills, Notes & Bonds outstanding)

Total GSE Debt & Mortgage Guarantees Outstanding: $6.19 trillion
(after the U.S. Government acquired 80% of Fannie Mae & Freddie Mac, the "implied" backing of the debt and guarantees was strengthened, just falling short of an explicit backing)

Total TLGP Guarantees Outstanding: $119 billion
(The Temporary Guarantee Liquidity Program provides backing for financial company debt via the FDIC)

2009 Budget Deficit: $750 billion (my estimate)
(The Congressional Budget Office will release their best guess at 10:00 am EST today.  The Office of Management and Budget's most recent guess is $482 billion.)

Total: $17.71 trillion

Tuesday, January 6, 2009

2008 Equity Market

So 2008 marks the end of a unique 10 year period: in the last 60 years (on a rolling 10 year basis) it was the only time the S&P 500 lost money.

2008 also marked the 4th year in the last 9 that the S&P 500 posted a negative total return, joining 2000, 2001 and 2002.

Since 1936, the average annual total return of the S&P 500 is 10.02% and the standard deviation is 18.17%. In other words: 68% of the time, one would expect the S&P 500 to return between -8.15% and 28.19%.

In the last 20 years, the average return is 8.33% and the standard deviation is 19.78%. More volatility, less return.

This is Not a Good Trend......

1/5/09: Adolf Merckle commits suicide after his conglomerate faltered under pressure from mounting debt and declining stock prices.

12/23/08: Rene-Thierry Magon de la Villehuchet commits suicide after losing most of his personal fortune and client's money in the Madoff scandal. The total losses are believed to be over $1 billion.

Back in the Saddle: Trends for 2009

The above chart is simply shocking to me. Uninsured mortgage related assets are still very dangerous to hold. There are /will be diamonds in the rough, but serious legwork will be needed. Mortgage loans originated from 2003 - 2007 are experiencing unprecedented defaults. It will only turn around when......

...this graph bottoms. It isn't an amazing insight, but banks will not turn on the money spigot until they believe the collateral on their loans is stable.

The above graph restates the case. Primary dealers typically hedge their interest rate risk by selling Treasury notes and bonds short, while holding risky assets. Their holdings of Treasuries is approaching FLAT and there has been a steady decline in corporate debt holdings. The Fed's participation in the MBS market has propped up primary dealers' holdings.

Money supply is still expanding, even though financial institutions are verrryyy conservative (see post on reserve balances from a week or 2 ago). This does not make for a good match for those who are long 3%, 30 year bonds or not as short as they should be.