Vox Rationalis

Today May Be Markets' Turning Point

I think the turning point is now. I mean now. Right... now. How about...now? Now? Maybe now. Now! NOW! Now now now now now...

Bail Out for Dummies - Part I

growser7 wrote:

> You can tut-tut all you like...

Being critical of somebody pushing the notion that the ENTIRE banking system may be twice as damaged as the 1,000 or so S&Ls that failed is "tut tut"-ing? I guess I wasn't clear enough - I don't know how bad it is, but Durden's suggestion of magnitude is ludicrous. I don't know how big the largest gorilla in history was, but I'm pretty sure King Kong was fiction.

> You can conjecture all you like about toxic assets and the FDIC...

I'm not the one guessing about toxic assets, and my discussion of the FDIC (which, again, has nothing to do with bank assets) was purely fact-based.

> what I am seeing is the federal debt ballooning at a rate which will swamp us all.

Perhaps, but perhaps not. Remember that the debt burden at the end of WWII was more than 120% of GDP, well above where we will be in a few years, and Japan's is much higher still. That said, I'm right there with you when it comes to persistent, non-crisis mode deficit spending. One of the very important lessons I hope we the people are learning is that deficit spending during expansions is like a noose tightening around the nation's neck; it causes nervousness and it's a little uncomfortable -- until the bottom falls out.

Will we remember the lesson when the situation isn't so dire? I'm afraid we may be repeating ourselves; during the Carter administration, the national debt was perceived to be a real problem. But then, once the economy turned around during Reagan's term, we forgot all about it, and grew the structural, persistent deficit in unprecedented fashion. Let's hope that cycle doesn't continue.

> The real monster in the closet is a lot bigger than you think.

You don't have enough information to know what I think. All I've written is that Durden's guess about the government's assessment is implausible, and that Roubini's assessment is very unlikely to be greatly exceeded.

Bail Out for Dummies - Part I

This article’s like a child looking into a dark closet at night. We're pretty sure there's something in there, and it’s really scary. But some of the details our imagination is trying to explain here aren’t nearly as bad as we think.

There are three problems with this piece: omissions, logic, and math. Other than that, it’s just fine.

First, Durden doesn’t adequately describe the FDIC's role, and doesn’t differentiate between it and the many programs created to deal with this crisis. Deposit insurance has been around for 75 years, and the only recent change is the insured deposits limit increasing from $100,000 to $250,000. Big deal? Not really, since CPI has increased 150% since the $100,000 limit was instituted in 1980. Really, the new limit just catches up to the 1980 level. If it were not changed, large depositors needing insurance would simply have been forced to open accounts at multiple banks.

Worse, Durden’s statement that “the various Bail Out programs now support OVER 72% OF THE TOTAL LIABILITIES ON THE BALANCE SHEET” (my caps for his boldface)” doesn’t mention that 58% of the dollars in Durden's “support programs” are in the FDIC insurance, not in a “bail out” program.

“The implications… $3.6 trillion, or another $2.4 trillion to go... $3.1 trillion in total US losses, or another roughly $2 trillion to go. These provisions are optimistic. Why? BECAUSE THROUGH ITS VARIOUS IMPLICIT AND EXPLICIT GUARANTEES THE ADMINISTRATION IS SAYING THE TOTAL PAIN COULD POTENTIALLY REACH $8.8 TRILLION.”

Nonsense. These programs do not serve the same ends, some overlap, and the size of the largest is unrelated to the banks’ assets. The FDIC’s insurance provides no direct support of the banks, except that it boosts depositor confidence. But the size of this backstop is tied to deposits, not loans. By Durden’s reasoning, if insured deposits increased by $100 billion tomorrow, the government would believe losses could potentially be $100 billion more. Or, taken to extreme, if insured deposits increased by $10 trillion tomorrow, potential losses could be $10 trillion higher. This is, of course, nonsense, since massive increases in deposits would DECREASE the chances of any loss, including a major one.

Add to the logical problems a mathematical one. Durden writes that the government thinks the banks could lose $8.8 trillion for the simple reason that the maximum value of the various government programs he mentions is $8.8 trillion. But look at the assets: the banks and S&Ls held $8.07 trillion of loans, according to the Fed data Durden cites. Add in $1.3 trillion in munies, corporates, and foreign bonds, $83 billion of equities and mutual funds, and $2.44 trillion of unknown miscellaneous assets, and the TOTAL possible losses are $11.9 trillion -- IF THE VALUE OF EVERY ONE OF THESE ASSETS AT EVERY BANK FELL TO ZERO. Durden thinks “the administration is saying” this portfolio could lose 74% of its value? Really?

Durden then bemoans the fact that the least desirable assets are increasingly being used as collateral for Fed loans, but this couldn’t make more sense. If, in the future, the banks need to sell assets, clearly they should sell those that are the least distressed (those that are closest to their expected long-term value). By allowing lower-quality assets as collateral, the Fed increases the chances that banks survive. And since this is the Fed’s goal, it would make no sense to tie up the banks’ best assets as collateral.

“…as we head to the full funding capacity on all the Bail Out programs ($8.8 trillion), Zero Hedge expects to see as much (not necessarily the full amount) as $7 trillion more of new Treasury issuance as the true "worth" of the assets is realized.”

So you actually think the banks’ portfolio as described above is worth as little as 42% of face value? Really? It's worth noting that the cost to the government of liquidating failed S&Ls averaged about 30% of assets. And that's the assets of just the failed firms.

“The scale of the problem is simply insurmountable using current mechanisms in place.”

You just got through explaining that you didn’t expect the government to fully use the $8.8 billion of funding programs, but now you’re saying it isn’t enough? So where is the scheme lacking?

“The bottom line is that every dollar printed by the Treasury directly goes to fund a dollar in deposits, bypassing M1-M3.”

I guess you didn’t know that most of these deposits are included in M2, and all are included in M3.

“If the $8 trillion pool in total deposits realizes that it is supported by assets which even the government is saying are worth fractions on the dollar…”

Psst… FDIC. Some 65% of all deposits have no need to be concerned with bank assets – that’s the whole point. As for the other $2.8 trillion, suppose it’s all withdrawn from suspect banks. Where do you think it’s going? Unless it’s going into millions of mattresses, those dollars will make their way back onto banks’ balance sheets. The funds won’t disappear – they’ll find their way to productive use. Such is the magic of the market.

“...the risk of a wholesale systemic bank run becomes unstoppable even with all the government backstops in place, as the latter will be contingent on continued willing recipients of those rapidly devaluing pieces of paper known as U.S. Treasuries and once that assumption is questioned or outright proven false, all bets are off.”

Wow. Congratulations, you win the “most absurd alarmist claptrap of the day” award. Financial markets are forward-looking, right? Then why, oh why, is the “rapidly devaluing” 10-year Treasury yielding just 2.86%? What was it before this rapid devaluation? Let’s see, in the last couple of months it’s... pretty much moved sideways.

I mean, it’s not like you’re the only one who has access to this information. The market’s pretty good at discounting known information – why aren’t your prognostications of doom reflected in Treasury prices?

The thing in the closet is real, and it is indeed scary. But Durden’s description doesn’t make sense. I don't know how big it is, but the odds that it's much worse than Roubini says are smaller than tiny. We may not figure out exactly what’s in there until the light of a new day.

An Obama Speech to Light Wall Street on Fire

Burke and Herbert is a local bank near Washington DC. It had record profits last year.

Record profits. In 2008. Not all banks have these problems.

Certainly there are thousands -- literally thousands -- of banks out there that did NOT overload on bad mortgages, that did NOT write CDS, that did not over-leverage themselves. Read your local papers, listen to your radio stations. You'll hear about them. They're the small banks that chose to really know their customers. They didn't fudge documents. They didn't sell and resell and resell option ARMs. They didn't try to make millions of dollars for their officers. They are responsible and their banks are in doing just fine.

By the way, there are some larger banks that are doing just fine as well. Their stock prices may not show it, but their financials do.

Don't you dare say that the big banks shouldn't bear the majority of the blame.

Why Capping Pay Is Likely to Work

Perrego wrote: "Agreed. But if you were offered options in a company where a lot fo the top talent left and it was going to be a few years before the TARP would be paid back, and THEN you had to rebuild your talent core competency would you think twice about staying? It's a slippery slope."

I understand what you're saying, but if the top performers were put under the same restrictions, they could be offered the same kinds of deals. To keep them the top end of the possible performance-based compensation (after TARP is repaid) would have to be higher, which they could do. At least then there would not be the open floodgate problem you suggest.

Why Capping Pay Is Likely to Work

Don't forget that on top of the $500,000 can be stock-based compensation, as long as it's not paid until the government's paid back in full. They could easily structure it so that their CEOs could end up making MORE. Which is fine - who doesn't think executives should have mostly performance-based compensation?

Goldman Says "Trust Us"

Do you really think Buffett believes that his $8B can have a significant impact on a market "on the brink of a systemic collapse"? Really?

BRK is better equipped to handle a significant downturn than perhaps any other company you can name. These investments were made because they were fantastic opportunities. Period.

As for GS and GE, they chose the cover of a BRK investment because of the very real possibility of a more expensive or a failed secondary offering. Could Goldman without Buffett have raised $7.5B at $110 rather than $2.5B at $125? Could GE without Buffett have raised $15B at $21 rather than $12B at $22.5? I don't know the answers.

Goldman Says "Trust Us"

Does anybody believe that Warren Buffett wrote a $5,000,000,000 check without seeing under the GS kimono?

History Suggests the Financial Bottom May Be Near

"Reminds me of the character in Animal House who is yelling during the parade "everything is fine - everyone remain calm" while the riot ensues."

That would be Kevin Bacon.

Financials Buying Opportunity Close at Hand

Voodoo.