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Tim Ayles
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We strive to build highly disciplined, sensible client portfolios. Portfolios that are focused on investing in businesses with solid free cash flows and solid dividend payouts. We buy businesses, not stocks. Tim is a Registered Investment Advisor.
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Napa Wealth Management, Incorporated
  • Is the Fed Buying Stocks to Reflate the Banks? 3 comments
    Sep 11, 2009 10:52 AM

    I wanted to update an interesting chart for an article I wrote recently showing the Fed is pumping the system with money, which is hitting the banks and then the stock market as a means to bail the banks out. With higher stock prices, banks can issue secondaries, thus flooding the market with shares and giving themselves cash to offset their balance sheet from bad loans. Also, since banks can't earn their way out of this mess via lending, the idea was tossed around that they are buying stocks for a massive profit. Stocks that they will sell and leave to the public, thus transferring the cost of the bailout to the public via the stock market. Take a look at the graph below from ZeroHedge.com, and then read the original article I wrote a number of weeks before:


    I realize this may sound like a nut job conspiracy theory, but I am just thinking out loud and wanting to document when this was thought of.

    Maybe, just maybe, the fed is inflating the banks through stock market gains. Stay with me before writing me off as a quack.

    On August 26th, Kate Berry from American Banker wrote an article titled "Postponing the Day of Reckoning" In it she stated:

    Banks also "are allowing borrowers to be delinquent for longer and longer periods of time before initiating foreclosures"

    This absolutely jives with what I see on the street. I have two close friends who haven't paid their mortgage in 10 and 13 months. Yet, they don't hear anything from their lenders.

    Is this because the banks don't want to book these non-paying loans as losses? The article continues:

    Tom Booker, a senior vice president in the default information unit at First American Corp. in Santa Ana, Calif., concurred. "There are borrowers who are six or eight months in default; they may have exhausted their workout options; but they're put on a forbearance plan because it's an interim to a final resolution, which is foreclosure," he said. "Banks don't want to take the losses now."

    Darrell Duffie, a finance professor at Stanford University's Graduate School of Business, said accounting rules give banks plenty of leeway to determine when to take losses.

    "Banks are believed to be carrying a lot of loans at accounting levels well above their true market value," he said. "But once a property goes into foreclosure, their options have disappeared."

    So the banks aren't realizing the losses, and they're doing nothing about it. People live in their homes for free, the bank loses thousands of dollars per client in interest income, but they are saved because they don't have to write off hundreds of thousands per non-payer in losses. Thus they preserve their capital ratios and allow them to live another day. Brilliant! (tongue in cheek) And scary!!!!!

    So here is a conspiracy scenario:

    1. Banks make bad loans and are crushed when the market tanks.

    2. Fed Prints money and gives to banks to keep them afloat.

    3. Banks don't write down loan losses, so their capital is not hurt, but lose interest income from borrowers not paying their mortgage.

    4. Banks need to earn an income to stay in business and "earn" their way out of these massive loan losses.

    5. Banks trading units "invest" in securities and the market and the market ramps non stop, thus offsetting lost revenue from loans with trading revenue.

    6. Banks eventually sell and leave investors holding the bag, thus getting their money anyway from the masses whom they lent money.

    I know - sounds crazy. But today I just read this from the UK Telegraph:

    Mr. Steinbruck said the markets are awash with liquidity again, but little is going into the real economy. "The banks evidently prefer to put their money into securities rather then granting new loans because they can get a higher return. After two years of financial crises the gambler mentality is gaining the upper hand again."

    The German authorities are deeply frustrated that so few banks have resorted to the rescue scheme to rebuild their capital base. Critics say the Bundestag imposed such stringent conditions that the lenders have opted instead to rein in lending.


    Does this not sound similar to what could be happening here? I know it's a black helicopter/conspiracy theory, but it seems the Feds and US are desperate to do something to change the reality they currently face. What better way to save the financial system than by bailing out the banks and not forcing them to write off bad loans after 180 days like GAAP requires. Instead, let them gamble in securities, and maybe even stocks? It will be interesting to see how well the trading units of the big banks do in the next few quarters.

    If this "highly unlikely" scenario is true, the banks will sell, have the cash they need to write off the massive loans, but will have sucked the money out of unsuspecting investors pockets. In the end - they will have won. They will have gotten the US investor, pensions, and retirement accounts to bailout their bad loans, and we can't get mad at the government because it didn't commit more taxpayer money to bailout more losses. Instead, asset price increases, and then selling those assets to investors, bailed them out. Or better put - investors "bailed" them out.

    Unlikely........ but interesting to ponder, no?

    I have wondered how my friends can live payment free for over a year. This theory could be a reason, even though it seems unlikely.

    In either event - remain cautious, and keep an eye on those bank trading profits.

    Disclosure: Long SH
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Comments (3)
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  • tagthatstock
    , contributor
    Comments (109) | Send Message
    i think your article is spot on.


    ever so slowly i think j6p out of need or revenge will stop paying his mortgage. a fellow trader told an entire of board of stock traders his real job is a rewriter for mortgages,,,,and he hasnt paid his own mortgage in months and has no intention of doing so until 2011 because that is when some rule window closes,,,,,,until then he trades and collect profits that more than cover his mortgage completely.


    currently the news is all about the job bubble. 90-80% employment,,,,,,lets say 20% unemployed....'we have too many people working' 'is working' in the markets,,,,,,,,for how long? i dunno. but will we work towards 80% unemployment? i dunno,,,,i guess we wait and see. for the past several years the media hated 95%+ employment. this leads me to the retail sales... at first the normal happened,,it got sluggish... but not as sluggish as expected...so i figure those not paying their mortgages are shopping with some of that 'new cash'...........


    we are in interesting times for sure.....something bernanke could never learn in a book or studies of the great depression if the paradigm is completely dif this time around.......namely 'technology' to out smart/work around his helicopter ride via computer 'daytrading',,,,,more cash movement than he can manage----for now. i can hear it now, when he does raise rates,,,,,the bulls will say its because of growth......no its because of bubbles that he played a part in creating.


    can you imagine every assett going up huge in price and still the demand falls off a cliff..... it would mess with the boys in school for years lol.
    8 Oct 2009, 07:38 PM Reply Like
  • Investment Observer
    , contributor
    Comments (12) | Send Message
    A very interesting article.... something that I've heard some refer to as the 'Cycle of Fleecing'.
    9 Oct 2009, 10:43 AM Reply Like
  • Illusion Maker
    , contributor
    Comments (90) | Send Message
    This is not such an unlikely scenario.
    Where do banks get all the money ?
    Where is it going ?
    Is this the biggest transfer in human history ?
    Save money and get 0% from the banks. Borrow money and pay about the same on loans and more on your cards. Is this interest spread a stimulant or a transfer?
    1% rate cause the credit depression. 0% is transferring it from the responsible to the irresponsible.


    No one in is right mind lends money at 0%. Banks certainly don't.
    When the cost of money is 0% guess where that money is going ?
    If you do have some Money, you convert it in to something that does not lose its valuation. If you are a Financial institution you borrow it at 0% and do the same. If you are the Master Printer (The FED) your are the only one that don't need any since you can print it and by Government Bonds to finance such things as stimulus packages. For every dollar printed for the stimulus package we have an equivalent dollar dilution in the economy. That's Houdini's economics. For politicians the added water in the lemonade does increase the lemonade but soon its going to taste a lot more like water.
    30 Nov 2009, 01:42 PM Reply Like
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