Five Factors Driving the Coming 'Transparency Squeeze'

Monday was not a technical correction - we saw the first major move down in financials due to the coming transparency squeeze. This squeeze is being driven by five factors - bank earnings' announcements, new mark to market accounting rules, the coming stress tests, future toxic asset auctions and the recent raise of new capital by Goldman Sachs (GS).

Earnings: The market not only does not like the fake earnings from Citi (C), BOA (BAC) and Goldman - accounting plus one-offs equal profits at these companies - but is really upset about the small reserves being set aside going forward. Simply put, these banks are not making any effort to be more transparent and by doing so investors are assuming the worst. The market voted - it thinks there is a large amount of bad stuff on their balance sheets - no kidding - in part due to a blog post that may or may not be real. The poster said they had seen the stress test results and 16 of the 19 banks were insolvent and there was an unspeakable amount of derivatives and other potential losses facing the banks, losses that would put the FDIC underwater in no time.

Assuming the blog post is false, the current lack of transparency and the small reserves being set aside are ridiculous enough to drive bank stocks lower. They are almost funny. BOA set aside just two and a half percent of assets - in a deep, deep recession with derivatives exposure as well?

Mark to Market Rules: They have changed but have actually hurt the banks more than they have helped. Yes, they let the fictional earnings statements seem brighter -- good for a headline and a trade - but they make investors, and the public, ask the question, "Oh, those assets are illiquid, eh? Sure they are not impaired?" And once all the banks declare what is impaired versus what is illiquid, investors can compare and contrast.

Stress Tests: Unless the government fiddles them, some banks must come up losers - and again, since the tests are being run with the same criteria, more data for investors to compare and contrast regardless of their conclusions. Stress tests of 19 banks' balance sheets are about complete with results to be released on May 4. in total. But over time individual results will be made public by the feds or the companies themselves as they are material to shareholders.

Toxic Assets Sales: Assuming they take place, these will a) produce clear marks for illiquid assets and b) provide a market for illiquid assets. You see where I am going with this - the mark to market accounting rules are mooted once an asset in a class is sold. No more illiquid assets - a bank can sell them at auction.

Goldman's New Capital: Goldman raised capital and the fall in the stock price was within a hair of the amount of dilution. And Goldman is valued as the best bank and the best brand in the industry. This means new capital coming to other banks will have at least that effect - and probably more given the perceived value of the Goldman franchise.

The transparency squeeze now makes it a transparency race. The government wants private capital to remake the banks - and they have created a transparency squeeze to get the ball rolling. Your point, Shulman?

The IMF says we are $1.3 trillion down a $4 trillion write-off. I believe them - and let's say it is only $3 trillion, that is $1.7 trillion more to write off or more than double the market cap of the industry. Capital will have to be raised and with that comes massive dilution of shareholders. Maybe even bondholders will have to take a haircut.

With the stress tests half political and half real, it is hard to say which banks will bounce when - we do know Citi, Wells (WFC), JPMorgan (JPM) and BOA have a lot of stuff on their balance sheets that needs to be written off. And many other banks as well. So, a short right now of an individual name may be difficult, or just volatile, but a short of the entire industry through puts on industry ETFs or the purchase of inverse ETFs on the segment is a great trade.

Comments

[doubleguns:]

The IMF has added hundreds of billions of additional writeoffs to our banks since Jan. Not that I completely believe anything the IMF says but it shows its not just us taxpayers think the banks have LOTS more writedowns coming.

Apr 22 08:05 AM

[asaf123:]

Bank earnings have risne to 41% of total earnings for US corporations. If you "correct" bank earnings to reflect the new reality (i.e. lower leverage ratio, fewer speculative instruments, etc.) I wonder what it does to the total S&P earnings. If S&P 500 earnings were $60 in 2008, what would be the "bank adjusted" earnings going forward, and what does that do to the S&P 500 forward P/E. I assume it would make the index look fairly pricey at its current 850 levels.

Apr 22 08:16 AM

[marketman54:]

Any reported bank earnings are worthless. Hanky Panky accounting can make anyone look good.

Folks the financials are going down : Phony accounting practices, existing toxic assets, greater unemployment creating more mortgage defaults, consumer credit card payment defaults, commercial real estate defaults, credit default swaps, no real lending going on, TOTAL LACK OF CLARITY IN THE BANKS!

Why would anyone want to own these things??

I agree with the author, play SKF on a day trading basis.

Apr 22 08:35 AM

[Private Joker:]

With all the hanky panky MS still had a huge miss. Could they be the sacrificial lamb for the Stress Test?

Apr 22 08:43 AM

[schlumpf:]

2 headlines yesterday:

The U.S. Treasury Department has not received the results of "stress tests" on the health of the top 19 U.S. banks
and
Geithner Says Most U.S. Banks Have Enough Capital

Hmm ............... ?????????????

Apr 22 09:00 AM

[nobby73:]

An illustration of the impact of the accounting rules - Citi made a profit owing to the fact their spread widened, Morgan Stanley made a loss because their spread tightened. We have moved into the realm of the absurd.

Apr 22 11:01 AM

[Warm_Paw:]

When you quote an unknown source on a web log your credibility flies right out the window.
Your short - right?

I agree the banks have a pile of toxic assets.
The masses are being stoked to cause a market rise so the Fed can mitigate losses dumping those toxic assets.
For that reason, the govt can't afford to be transparent.
If we knew the truth, we wouldn't be coming out of this.

Now the flood of money into the system is what's bringing about the rise in share buying. Not earnings.

The accounting rule changes are a farce and the banks know they may end up paying taxes on gains they truly didn't earn. That's why they hesitate to give guidance going forward. They're not sure they want to claim the gains.

Geithner needs those artificial gains to get this market off the sandbar.

Not sure what the answer is.

The herd moving into stocks may just get the govt plan to work.

Smart money's still on the sidelines. Investor money. Spec money is being laid on the table. That money getting wiped off the table might be a good thing anyway.

Apr 22 11:12 AM

[dcb:]

What do you do when the market isn't rational? What do you do when one company is doing a lot of the trading and when they want to they can decide to take profits and drive the market lower? what do you do when the government is engaged in a deliberate disinformation program.
Does anyone believe the results of the stress tests regardless?
I read that regional banks will suffer at the expense of connected wall street firms.
I hate to say this but the whole thing greatly reminds me of the of the bush administration disinformation campaign in Iraq. I think it is best to view things that way.

Apr 22 12:08 PM

[dcb:]

I saw 25X some where from someone who did the calculations and it look reliable.


On Apr 22 08:16 AM asaf123 wrote:

> Bank earnings have risne to 41% of total earnings for US corporations.
> If you "correct" bank earnings to reflect the new reality (i.e. lower
> leverage ratio, fewer speculative instruments, etc.) I wonder what
> it does to the total S&P earnings. If S&P 500 earnings were
> $60 in 2008, what would be the "bank adjusted" earnings going forward,
> and what does that do to the S&P 500 forward P/E. I assume it
> would make the index look fairly pricey at its current 850 levels.

Apr 22 12:10 PM

[dcb:]

another problem is that every time the futures are lower it is a buying opportunity and them being higher at this point is a selling opportunity
when things look neg (futures) you buy. we haven't had up futures in a while i think (at this level)

Apr 22 12:12 PM

[Misha:]

People long banks must be concerned that current assumption is that all big banks will pass the stress test. Therefore, if, in fact, they do pass, there is no upside surprise. At that same time, as the response to Monday’s rumor shows, any negative information coming out of this test will be a surprise.

As for GS, I have to say that these guys are the best timers in the world. You can mark markets tops by the timing of their equity offerings.

Apr 22 12:55 PM

[Jason Rines...:]

If your going to report the validity of 'blogs' why not include the link to the blog? For those whom wish to know:

turnerradionetwork.blo...

Apr 22 03:47 PM

[Rocknbob:]

to Jason Rines : thanks for the link!

Apr 23 03:10 PM