retired aviator

All Banks Are Insolvent if You Believe They Are

Milton said: "If one uses the market prices of the mortgage securities instead of their book value then one would conclude that banks that hold them have assets that are less than liabilities and are insolvent. If one would use likely cashflow projections without government intervention then these banks are solvent."

Milton makes a great case here - one of the best explanations I've read of the actual MBS market valuations. However, it is based on 'efficient markets' theory and the financial markets are anything but efficient. If they were, we would not have had a dot com bubble.

Especially in the volatility of the past months, when large institutional holders were deleveraging en masse, buying support couldn't possibly match the volume and create an 'efficient market'.

MBS are inherently different from the more complex default swaps and other derivatives as there is hard real estate collateral in a worst case scenario. Home values can only fall so far, so worst case cash flow scenario is some depressed home market value, minus costs to foreclose. Seems the mortgage market has already priced in about a 100% worst case scenario. Extreme fears priced into some equities and debt instruments now may prove ultimately justified, but the mortgage market in my opinion is an area of opportunity because the downside is more than priced in.



On Mar 02 06:43 AM Milton Recht wrote:

> One of the logical reasons for the apparently excessive market price
> discounting of mortgage securities is the market anticipated the
> Federal government's intervention into the mortgage contract which
> diminished the value of the securities. The Federal banking agencies
> and Congress are forcing the banks to extend mortgage life, decrease
> the interest rate, decrease monthly payments to a lower percentage
> of income, and delay foreclosure proceedings. Also, there are strong
> indications that banks will see the principal amounts of the mortgages
> lowered, either through bankruptcy judges or voluntarily. All of
> the above factors and others cause mortgage securities to be worth
> significantly less than originally anticipated based on default rates
> and cashflow.
>
> As the data on the current mortgage crisis reveals itself, it is
> becoming increasing clear that four states were the cause of the
> current banking problem. California, Nevada, Arizona and Florida
> account for most of the subprime, no income verification, underwater,
> defaulting mortgages, and foreclosures. Much of it was caused by
> the above average and rapid house price appreciation in these states
> combined with lax state regulation of mortgage bankers and originators
> within these states.
>
> While in all recessions there are always calls by some of our Congressional
> representatives to help homeowners in foreclosure, this time around
> we had the US Senate and the House of Representatives controlled
> by individuals whose states were at the forefront of the problem.
> Pelosi is from California and reid is from Nevada. It was also clear
> during the 2008 presidential campaign that a Democrat was most likely
> to win the White House due to Bush's and the Republican's very high
> unfavorably ratings and that the Democratic winner would likely accede
> to a Democratic Congress on helping mortgage borrowers in trouble.
>
>
> The depressed market prices for mortgage securities in early 2008,
> which led to the Bear Stearns collapse, were lower than many anticipated
> by the then actual and foreseeable cashflows on the mortgage securities.
> Even today, the payments are better on these mortgage securities
> than market prices would suggest. The disconnect between expected
> cashflows and market prices has caused the most problems in motivating
> banks to take write downs and in attempting to come up with a federal
> government solution.
>
> If one uses the market prices of the mortgage securities instead
> of their book value then one would conclude that banks that hold
> them have assets that are less than liabilities and are insolvent.
> If one would use likely cashflow projections without government intervention
> then these banks are solvent.
>
> Insolvency is the trigger for government intervention of the bank.
> So, the insistence by the banking regulators and the Treasury to
> use market prices instead of cashflow projection prices has caused
> the deterioration in banks' equity stock market prices and insolvency.
> However, Krugman and others should recognize that mortgage securities
> prices are excessively depressed due to the involvement of the Democratically
> controlled Congress and White House in coercing banks' to modify
> mortgage loans.

A Simple Housing Fix: Government Buy-Down of Mortgage Balances

To kelm:

The banks going under and a consequent bank run could collapse our whole financial system and ratchet up the panic level a lot, even from here. For those who hate to use taxpayer money for bailouts, how would you like a possible alternative of going to get money from your bank account and finding out the money's not there, and the FDIC deluged with more depositor insurance claims than it can handle?

His solution is beautiful in its simplicity. The banks get capital that's not free but must be paid back, they write back up some of the write downs, and homeowners get lower mortgage payments. A lower mortgage payment puts $ in pockets the same as jobs do and allows more disposable income for consumer demand to help the economy. Your statement it "Does nothing for the broader economy" is hogwash.


On Feb 25 08:50 AM kelm wrote:

> This is completely misguided (and not at all original as I have seen
> the same misguided idea on SA a few times in the last weeks). Taking
> equity stakes in homes makes people happy but does nothing for the
> broader economy, nothing to re-balance the economy, and nothing to
> restart job creation. How is it that people who are supposedly part
> of the financial industry are so prepared to throw fundamental economics
> to the wind with ideas like this? Probably because they will profit
> from them.

Stocks Are Cheap: A Response to Tim Knight

Many stocks are cheap no doubt. Actually, most companies that survive the recession without bankruptcy reorg. and return to profitably and earnings growth in the future are cheap today. The market simply isn't pricing in earnings 5, 10 or 20 years from now - the market is assuming the worst.

It's hard to be a bull in the midst of the most bearish sentiment in a generation. (It was also hard to be a bear during the dot com bubble.) Don't let it get to ya!

Recession, Not Depression

Lok, I have to agree with you wholeheartedly.

The financial markets have gone too far in devaluing securities relative to the economic fundamentals. The 'doom and gloom' attitude that prevails is because: 1) almost all the news for months has been about economic and financial crumbling; (yet the current economic statistics are nowhere near 'Depression' levels (unemployment, GDP contraction, deflation, etc.) 2) the stock market plunge has seemed to verify the theory that everything is going to hell, and 3) short sellers are now enriched and emboldened - they feel their thesis has been validated. At the same time, long side investors were burned repeatedly buying on any 'dips' in the last year - as a result, they are too poor and whipped to buy any more. That's why there is a lack of support in the market, as the big funds don't get any net inflows. If the market keeps going much lower, it will be nothing more than a reverse bubble - the ideal time of a lifetime to buy in.

The stock market in the late nineties was irrationally exuberant, but you could hardly tell anybody that at the time (Greenspan tried). Now it is irrationally morbid.

In the end, it's all about earnings and all these theories being bandied about won't mean a thing. Earnings will return and they will resume inexorable growth at some point. The question is when.

Interestingly, even if we have a 1930's Depression, by all historical accounts now would still be a good time to buy stocks! After every 40%+ market decline in US history was a great time to buy from the viewpoint of 5-10 years later.

Some Misconceptions About the Great Depression

This is a good article. Numbers don't lie when used properly. The strong recovery during the 1930's is a hopeful sign. Personally I think the "Depression" outlook so common today is overdone.

As go aggregate demand and corporate earnings, will so go the 'economy' and employment levels. Americans can only reduce spending so much. It is forgotten now that low oil prices, rock bottom interest rates, and massive stimulus are real effects that will go to the corporate bottom line.

When debt is finally sorted out, I'm afraid of actually too much GDP growth too quickly with all the above stimulus!

Though you argue well that the 30's was not a decade-long misery for America, there was no parallel respite for equity investors. An investor in the Dow average in the late twenties was underwater until the 1950's. Of course a late twenties buyer of stocks was overpaying (certainly not the case today), and the pain was mitigated by outstanding dividend yields during the painful era.

Basically what happened was a fear of stocks kept investors away for many years after the crash. So for many years stock prices did not gain ground as their earnings and dividends did.

Not a problem for the buy and hold investor! Warren Buffet is the great example of this. He doesn't fault holdings' management for stock price falls, but focuses on book value.

Anyway thanks for the data!

WSJ Weighs in on Peter Schiff

"Batteries!" LOL

Reminds me of when on his radio show he was replying to a caller who asked about holding US dollars and he responded that the only US money he should hold was pennies and nickels because the intrinsic value would be well above face value (cost) in the coming commodity boom.

So apparently jars of pennies are a good investment or hedge to Schiff!

What's the wife going to say when you convert tens of thousands of dollars into pennies and nickels and fill up the house with them?

For a guy who made some great calls and comes across as highly intelligent and articulate on talk shows he occasionally really makes you wonder.



On Jan 30 10:49 PM otbricki wrote:

> The Peter Schiff story is not new. Every down market gets predicted
> by some group of permabears. A broken clock is right twice a day.
> Roubini and Schiff and so on are the names this time. These people
> generate a cult following based on this call.
>
> The same permabears often run investment funds that ruin their clients;
> the permabear is only right in some macro sense. Despite the fact
> they have predicted the bear, they haven't been able to translate
> that into a benefit for their clients. That is the first warning.
> The second warning is that they start talking about not being market
> timers. Well isn't that what they claim in their macro predictions?
>
>
> Look up another well-known permabear, Joe Granville. For two-and-a-half
> decades he averaged a -20% annual performance. His seminars sometimes
> featuring a trained chimpanzee who could play Granville's theme song
> "The Bagholder's Blues," on piano.
>
> Peter Schiff had an interview on Seeking Alpha recently where he
> advised people to buy batteries to tide them through the coming economic
> collapse. That says it all for me.
>
> Batteries.
>

Buffett Is Not a Leader, Just a Great Investor

"Ultimately, Buffett has always been too much of a "taker" to give enough to develop leaders."



The author needs to do more research before penning about Buffett. The above statement is patently false. A "taker"? - he has contractually pledged probably 99% of his wealth to charity on his death. He has testified before Congress that Congress should raise his taxes! He has been a tireless advocate against the Wall Street greed mentality his whole career.

He doesn't choose to author books to mentor investors. Why should he, with Graham's books timeless and available? All the guy ever wanted to do was the thing he was always meant to do - allocate capital. He is about the most blameless individual you could possibly choose to fault-find over.

Government Stimulus, If Done Well, Is the Right Decision

Bravo, Lok! I think your analysis is sound and a breath of fresh air amongst the doomsayers. The important thing now is not to bemoan our current economic straits, but to think constructively and carefully about a plan going forward. The housing price support makes tremendous sense.

Though I'm generally no fan of big government borrowing and spending, I too recognize its stimulative benefits during this crisis when the private sector is madly contracting.

With historic low interest rates, the Treasury borrowing makes that much more sense in this crisis. Over time, inflation and rising interest rates (only one way they can go from here) will erode significant debt while the current borrowing cost on $1 trillion is a mere $10-20 billion or so a year.

The question is whether the Treasury can ultimately find enough lenders (other than Fed printing) while needing to roll over or retire $2.6 trillion of its debt maturing in just the next 12 months alone!

The Fallacy of Floating Exchange Rates

I think that many years from now world leaders may wake up and realize that having to have currency exchange between nations at all is like a ball and chain, and the numbers of different currencies will diminish as nations merge currencies, as in the euro. Ultimately, it would be best to just have as single world currency, in my opinion! Currency exchange is beset with all kinds of economic and political problems, and is essentially an unproductive waste without any benefit to the whole.

Definitely No Shortage of Money

I think many posters have mistaken the author. I don't think he is predicting economic upturn.

What he is saying is that fear is paralyzing a colossal amount of investment money from greedily scooping up bargains. Many equities and other assets are priced probably lower now than we are likely to see again in our lifetimes. The author is only pointing out that any market rally's power will not be limited by money, but only limited by other forces.

Deflation Is Mostly Behind Us

John Polomny said: "It is a historical fact that the central banks can create inflation that will manifest in rising prices."



I am having a problem with the above statement. It makes the money supply/rising prices connection seem predictable and controllable when it is not. I believe such a correlation also is not a historical fact at all. Though rising prices and money supply have often been correlated, as often they have not. Certain economies at certain times, i. e. hyperinflation, yes the connection is clear.

But the causation during more stable inflationary times is much clearer in the exact reverse of what you claim.

For example, since money is created when banks write loans, higher prices will necessarily cause loan amounts to be greater, and therefore money supply creation to also be greater.

This would explain why the high price inflation of the 1970's and growth in money supply then correlate. It was the higher prices causing the increased money supply, not the other way around.

Other periods with more stable or slightly rising prices do not correlate much to money supply growth.



On Jan 19 10:34 AM John Polomny wrote:

> Yes there is inflation, MZM, True Money Supply, M2, M3 (as calculated
> by John Williams at shadow stats) are all increasing. Inflation is
> an increase in the money supply. CPI declines because of a collapse
> in energy prices is not deflation. It is a historical fact that the
> central banks can create inflation that will manifest in rising prices.
> read Mervyn Kings paper "No money, No inflation" for an explanation.
> In his article and the charts provided he shows the time lags involved
> in the process of inflation manifesting in higher prices..
>
> www.bankofengland.co.u...

>
>
>
> On Jan 19 05:52 AM constructe wrote:

Government Bonds Are the Latest Bubble, Probably Not the Last

I think a ton of institutional money during and since the fall panic moved into US Treasuries because the fund managers can appear 'blameless' for being in what has historically been the safest harbor. It's not their own money, so maybe they are yield-blind.

I also know personally of instances of individual retail investors rolling over their treasurydirect.gov accounts in complete ignorance of current yield! I pointed out to a smug acquaintance of mine who recently rolled over $200k in 6 month bills (and has done this for years), that the next maturity payment is going to have a shocker for interest - APY is only .27%, down from 7 times that for their last interest payment! This bozo had no idea what the yield was, even with the statement in hand!

I think the splash of cold water these investors get when their T-bills start maturing in Q1-Q3 2009 will have to start releasing significant air from the Treasury bubble as they bail for better yield.

Is the U.S. Solvent?

I'd like to see a defense of this author's bold statement:


" For those of you who don't know, when everything is shaken out, money supply growth exactly equals price inflation."

I know of no empirical or conceptual proof of money supply growth quantitatively predicting inflation, even roughly, let alone "exactly".

M2 Money Supply Indicates No Shortage

Good article. It's hard to tell for sure if money growth is good or bad, though. For credit-worthy folks taking advantage of historic interest rate lows to borrow, it's good. I'm also not worried about lenders standards for creditworthiness - not anymore!

What the M2 doesn't tell us is how much money growth has come from Fed open market purchases, rather than lending. This cash being created could be a bad thing, meaning the demand for Treasuries is partly artificial, and the cash creation is not from confidence of lenders and willingness of borrowers, but rather something potentially troubling going on with Treasuries.

What Is the Monetary Base?

I'm finding this to be a greatly enlightening article. I thank you. I do have a problem with this statement though:

"If the private sector holds more base money than it needs, it will normally use the excess to purchase interest-earning Treasury securities, since base money earns no interest.Thus the Treasury will always be able to recapture its deficit spending through the sale of securities, since it can pay whatever interest the market demands."


There are mnay other interest-bearing vehicles and no need for the public to plow extra cash particularly into Treasuries!