America's Insolvent Banks 29 comments
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John Hempton has 5,155 words on bank insolvency today, and makes the good point that "insolvency" is not well-defined. So what do I mean when I say that some big banks are insolvent? I mean that when you look at assets you shouldn't include things like goodwill, and instead concentrate only on concrete things like cash and retained earnings; then, value loans on a held-to-maturity basis. If you do that, those assets are worth less than the face value of total liabilities.
Hempton makes the good point that mark-to-market values are significantly lower than held-to-maturity values because the buyers of distressed loans want much higher returns (on the order of 15%) than the discount rate (on the order of 5%) that you'd use to value a held-to-maturity value.
So how do you work out a reasonable held-to-maturity value for an asset book? As Hempton says, you can't trust the banks themselves to tell you, because they will lie: the downside to telling the truth is death. His idea is to use TARP funds to capitalize ten different funds, each of them mixing public and private capital, and each of them buying banks' assets using cheap money as funding. That should give a good basis for a vaguely realistic valuation.
But is that really necessary? We already have such funds (capitalized with public funds, with access to cheap liquidity): they're called banks. No one trusts Citigroup when it takes a bunch of nuclear waste on its trading book and suddenly reclassifies it as being held to maturity and therefore exempt from mark-to-market requirements. But if JP Morgan was to buy the stuff on Citi's trading book, and Citi was to buy the stuff on JP Morgan's trading book, then at that point the prices would be much more believable. And these big banks have a very low cost of funds indeed, thanks to a Fed which is more than willing to provide them with essentially unlimited liquidity.
Hempton is also convinced that given a few years, banks will be able to recapitalize themselves all on their own, out of operating profits:
The pre-tax, pre-provision income of the banking system normally funded is probably 300 billion. It is probably much larger if the funding costs were reduced to near Treasury levels. If you haven't noticed interest rate spreads and hence pre-tax, pre-provision profits of the banking system should (presuming normalised funding) be way way up. 300 billion is an underestimate. So if there are 2 trillion of losses and 1.4 trillion of starting capital then four or five years and we are back to fully capitalised. We would get back there faster than that - because the banks have raised considerable capital on the way down and not all the 2 trillion of end losses are born within the banking system.
I'd take issue with some of these numbers: $300 billion a year is $3,000 per US household per year. That's real money. We're entering a world where households have lower borrowings, higher savings, and much greater awareness of the banking system; we're also entering a world of much stricter bank regulation, which means less opportunity for banks to gouge consumers when it comes to fees. So do I believe that the banking system will be making something like half a trillion dollars a year in operating profits if and when it gets back to some kind of steady-state sustainability? No.
I'm also dubious about the $1.4 trillion in starting capital -- that's regulatory capital, which is a very different animal from something like tangible common equity, and importantly it includes preferred shares, which I, for one, consider much closer to being liabilities than equity as far as a bank is concerned.
Hempton thinks that on this basis the system is "brimming with solvency"; if I had to point to one place where I clearly disagree with him, it would be here. I think that on a snapshot basis the system is worse than he calculates, and I also suspect that going forward the ability of the banking system to recapitalize itself is much weaker than he thinks.
Still, he's indubitably correct on the subject of the "Geithner plan" -- which is one of those phrases that genuinely belongs in scare quotes:
As far as I can see there is no detail - and if you don't have detail you don't have a plan.
This is one of the reasons I'm becoming increasingly convinced that we're turning Japanese: given how hard it is to do something bold, it's always easier to faff about and do something woefully insufficient. Unless and until Geithner announces a plan worthy of the name, we'll have to assume that to be the base-case scenario.
Disclosure: No positions
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On Feb 17 03:32 AM gtmcduffy wrote:
> I notice there is no disclosure from the author as to his holdings
> of the stocks discussed in this article (which there is supposed
> to be)...readers- please be cautious in regard to the underlying
> motives of this author...
Please enlighten us because I get tired of the separation!
On Feb 17 03:32 AM gtmcduffy wrote:
> I notice there is no disclosure from the author as to his holdings
> of the stocks discussed in this article (which there is supposed
> to be)...readers- please be cautious in regard to the underlying
> motives of this author...
On Feb 17 09:20 AM vreporter wrote:
> What's the difference between a US investor and a US taxpayer? Please
> enlighten us because I get tired of the separation!
There was 400 Trillion dollars of derivatives (MBS, CDO, CDS, etc) valuation.
There are 100' of billions of dollars of distressed properties on the banks books.
The Commercial Real Estate market is crashing and taking the Regional Banks.
Credit card defaults are spiraling out of control.
Now let't take the Derivatives....if just 5% were real money, that's 20 trillion dollars. That's more than the combine total of the top twenty banks in this country. We know for a fact the Europe's banks hold 24 Trillion dollars in rotten assets.
So are the banks broke. Yes....and if some are not they soon will be.
As far as Geithner having a plan or not....OF COURSE HE DOES NOT! How can anyone on this planet have a plan to bail out the banks who are involved in the World's Largest Ponzi Scheme gone bad?
I'm sure your "ironpants" are beginning to rust from all that load you dropped from missing all the short selling you could have done.
Of course Japan's 13% drop in GDP and about the same in Manufacturing is all because of short sellers too.....I mean, we the American consumers don't buy anything from that country anyway....
Right?
On Feb 16 06:40 PM goldenhinde wrote:
> Proposal: It is time that we eliminate the privatization of profits
> and the socialization of losses.
>
> Summary (one page)
> US taxpayers are being asked to incur massive debt to recapitalize
> insolvent financial institutions. While a sound banking system is
> required to drive economic activity – HOW we implement this rescue
> is critical. If the rescue of these institutions is adopted as proposed,
> (the “good” bank / “bad” bank proposal) we will recapitalize the
> same management, Board of Directors and oversight structure that
> created these catastrophic circumstances in the first place. If
> adopted, this proposal will effectively shield them from having to
> bear responsibility for their actions. In addition, it will impose
> a debt upon us that is so burdensome it will strangle our capacity
> for economic growth, threaten our liberty and diminish future opportunity
> for our children. There is no measure of maturity, honor or decency
> in encumbering our children with massive debt to pay for our generation’s
> mistakes and the inept management of our affairs. We must demand
> an alternative course of action from our government. This Proposal
> offers such an alternative.
>
> In this Proposal we citizens propose that in exchange for US taxpayer
> infusions of capital all of the securities representing the ownership
> of these businesses (see Provision #3 for the exception) will be
> treated as though the business had actually made a bankruptcy filing.
> When US taxpayers recapitalize the insolvent institutions, a new
> class of shares shall be issued. Those securities will: (1) become
> the property of the US taxpayers and (2) be deposited into a Trust,
> called the Social Security Trust, for the benefit of all Social Security
> system participants.
>
> As the business activity of the citizenry revives the economic vitality
> of these institutions, the value of shares in those rescued institutions
> will increase. As they increase in value they will become the financial
> backbone for the Social Security system – a system that now has no
> real assets but for the social security taxes taken from future payrolls.
> The SST shall be managed by a FIDuciary Oversight Board (seekingalpha.com/symbo...)
> whose members shall; be experienced investment fiduciaries, report
> directly to the President of the United States and be subject to
> oversight by the General Accountability Office. When there is clear
> evidence that the rescued financial institutions are stable, the
> FIDOB may examine the prudence of selling the securities to the highest
> bidder in the marketplace. While such a program would require the
> President’s and GAO’s approval, the proceeds from a sale will remain
> as SST assets.
>
> By implementing the actions proposed in this Petition, we citizens
> of the United States will:
> • recapitalize the financial infrastructure of the country,
> • employ market-based principles consistent with the intent of our
> laws,
> • substantially alleviate (not solve) the financial burden upon our
> children of paying for Social Security benefits we have promised
> to give ourselves,
> • create a governance model grounded in and guided by an authentic
> fiduciary standard of care (not how banks or bank regulators operate
> now),
> • establish a Trust with real assets that serve as a financial backbone
> for Social Security, and
> • exemplify our President’s call for individual responsibility.
>
>
> Please visit sociallyresponsibleres... to read the entire
> 7 page Petition and sign it.
> Pass it along to friends, family and colleagues. Thank You.
"There was 400 Trillion dollars of derivatives..."
Surely this figure can't be right. Perhaps you meant $40 trillion?
400 trillion is such an astronomical amount that I don't think we can even fathom it.
Just checking.
Quote: No one has any idea of the magnitude of the deleveraging ahead or the size of the debts that will have to be written down. That's because 30 years of deregulation has allowed a parallel financial system to arise in which over $500 trillion dollars in derivatives are traded without any government supervision or accounting. End Quote
www.marketoracle.co.uk...
On Feb 17 11:34 PM ArtfulDodger wrote:
> Sentinel:
>
> "There was 400 Trillion dollars of derivatives..."
>
> Surely this figure can't be right. Perhaps you meant $40 trillion?
>
>
> 400 trillion is such an astronomical amount that I don't think we
> can even fathom it.
>
> Just checking.
"retained earnings" are a component of shareholder equity, so are a liability not an asset.
Someone should run for congress on this slogan.
uhh.. please ... open an accounting textbook, before you say nonsense. There are only two kinds of items in the balance sheet, ASSETS and LIABILITIES. Both preferreds and common equity are liabilities.
That figure is a best guess conservative figure. Watch "The History of Money" based on the book and that figure is given as well.
Because a lot of this is simply Monopoly Valuation, the true value is somewhat unknown. However, some very smart people have also said the figure is as high as 700 trillion.
I know that these figures are absolutely mind-boggling. However, all you have to do to come up with 600 trillion dollars and know that it is spot-on accurate is simply look at every countres' total debt obligation on this planet.....
....and simply add.
And you will get 600 trillion dollars. So when you realize that most of this derivative valuation came from debt instruments (ie mortages and such) plus the multiplier effect (you know....for every 1 dollar spent or 1 dollar of debt you can "leverage" that 10:1...50:1 even 300:1) and you can now see how 400 trillion is a good ball park estimate.
By the way....the President of the Dallas Fed was on C-Span a few days ago and he put the entire National U.S. debt (all on-the-books and all off-the-books) at 88 trillion.
Here's the scary part......that did not count ANY....I repeat.....ANY of Paulson's TARP bailout, the U.S. automakers' bailout, and The Messiah's Stimulus Package.
It is a metaphysical certainty that our total National Debt will exceed 100 trillion dollars by the time Obama is run out of office.
The banks enabled this. Now they are crying "I'm a victim" because they took advantage of a system which, between banks and the government, enable people to consume more than they produce. And they didn't even apply for welfare.
I'm a broken record on this point but with $1.5 T in TOTAL assets amount the Top 5 and $170 T in motional derivative contracts, the spread on their lending practice has become almost a non-issue. The question is always, "What are toxic assets worth?" The question should be, "what's the exposure to the taxpayer of these institutions still being leveraged 44-to-1 in derivatives?"
The large, toxic institutions (versus toxic assets) are ALREADY insolvent - we should go ahead and put them six feet under and back-fill the void (if any) be recapitalizing the local/community banks who avoided heavy leverage in derivative product (most of them).
Plus, BRING BACK GLASS-STEAGALL and we'll all sleep better.
Want to be a bank? Then make loans. Want to trade and deal? Be an investment bank. But the two together have ALWAYS been water and oil.
On Feb 17 02:23 AM jimmy46 wrote:
> A major factor in evaluating banks today should be their earnings
> capability.
>
> With the cost of funds so low, I'd think most banks are making a
> killing on their new loans.
> This can pay for the bad loans they made in the past.
www.ny.frb.org/newseve...