CautiousInvestor

Ultimately, Who Benefits from Too-Big-To-Fail

If we put aside the arguments put forth by Charles Calomiris and concentrate upon the author's headline question, it is immediately apparent in the most narrow sense its the management and the equity stakeholders of too-big-to fail institutions that most immediately benefit the doctrine. Knowing their firm is backstopped by the US Treasury, management of TBTF institutions will be inclined to take outsized risks to generate profits that will increase their bonuses and the equity values of their firms. If the risks are kept within bounds, all is well; if the risks are too great and deals fall apart, the losses will be socialized. As Volcker and Mervyn King have noted, this mentality can not be regulated away.

Diana Farrell And The White House Theory Of Bank Size

In addition to the too-big-to fail doctrine and regulatory capture, the real reaon there will not be meaningful reform, including reducing size and concentration, is that the bankers/brokers effectively control the administration through ownership of congress. From Washington's Blog:

Lobbyists from the financial industry have paid hundreds of millions to Congress and the Obama administration. They have bought virtually all of the key congress members and senators on committees overseeing finances and banking.

This is easy to confirm in black-and-white. See for yourself: here, here, here, here, here and here.

Manhattan Institute senior fellow Nicole Gelinas says:

The too-big-to-fail financial industry has been good to elected officials and former elected officials of both parties over its 25-year life span

And economic historian Niall Ferguson says:

Guess which institutions are among the biggest lobbyists and campaign-finance contributors? Surprise! None other than the TBTFs [too big to fails].

No wonder two powerful congressmen said that banks run Congress.

No wonder two leading IMF officials, the former Vice President of the Dallas Federal Reserve, and the the head of the Federal Reserve Bank of Kansas City have all said that the United States is controlled by an oligarchy.

With the exception of a handful couple of Congress members who have the American people's interest in mind, Congress is bought and paid for.

FHFA's DeMarco Speaks. Remarks Offer Little Room for Optimism

Our government must have more shoes than Imelda Marcos; on the same day the Senate heard DeMarco they also heard from the head of the FHA, another likely shoe to drop.

FHA foreclosures are up something like 75% and 20% to 25% of the loans issued in the last two years are in trouble. Ginnie packages FHA and VA but the guarantee liability rests with FHA.

From today's NYT reporting on a content FHA customer:

That was the case for Bernadine Shimon. Like many Americans, Ms. Shimon has recently been through some rough times. She lost a house to foreclosure, declared bankruptcy, got divorced and is now a single mother, teaching high school English in a Denver suburb.

She wanted a house but no lender would touch her. The Federal Housing Administration was more obliging. With the F.H.A. insuring her mortgage, Ms. Shimon was able to buy a $134,000 fixer-upper in August.

“The government gave me another chance,” she said.

UNBELIEVABLE!!!!!!!!!!!! Barney Frank said the program was helping to stabilize housing prices.

Post Traumatic Crash Disorder?

A number of the technicals were starting to scream sell; a strong sell came from the McClellan (AR) Oscillator which has been descending and was just touching zero (sell at zero when the signal line comes from ablove) late last week.

Your comments on the traders playing out the sentiment and momentum play are interesting because there are in for a day on a day trade or a couple of days on a swing. This is is exactly why the four junk stocks have acounted for 30% or so of recent volume.

Without delving into the fundamentals of this market, which in a manner of speaking do not exist or are either weak, the moves since the 666 lows of March have been characterized by low volume, imbalances between large cap and small cap, low grade issues enjoying big moves and serious and unrestrained excesses in valuations.

Sobering Stat: ARMS Index Indicates Market Is at Peak, Not Bottom

A host of the technical indicators I use have been warnings but this market is being driven by historically unique forces, including massive deficits and proportionate liquidity injections, or is being supported my the machinations of the Fed. In either case, what in the past have proven to be useful tools are being compromised, if not castrated, in the current setting.

The market is clearly overbought and has risen to unsustainable levels. It was first better than expected earnings, then it was the growth of China, then it was about housing and other reports, then it was we sold a few more cars through the clunker program and now we are starting to take stock of the basics. They have remained unchanged and over the long-run these cannot be abrogated by either liquidity or complicity.

Growth in China is in serious jeopardy and central authorities are genuinely concerned about creation of excess capacity and speculation in commodities, casino's and equities. Recent policy actions, designed to mute some of the excesses, has been initiated over concern of these excesses and the larger unspoken concern over the financial health of the economy. Corporations with deteriorating earnings are borrowing more money; under usual conditions they would be denied additional credit. In parallel, banks are concealing non-performing loans through rolling them over. Some smart people, including Micheal Grant, think China is a ticking time bomb.

Meanwhile, stateside, the core problems of underemployment, consumer spending and bankiing sector health remain unchanged.
To an extent consumer spending and underemployment are intertwined; but even if consumers, who have jobs, were not frightened by the economy and the administration's policies they would still want to save and liquidate debt therby containing spending. Prospects for the unemployed are miserable and, unfortunately, government and the apparatchiks of MSM do nothing to either clarify or correct the resports released federal departments and agencies. The bottom line is hiring is still trending down amid a growing potential labor force.

If China follows the path of Japan, the model country that could do no wrong until 1989, and the US consumer spending continues to contract, what will be the catalyst to spur growth and profits? Many times people when confronted by such a question will resort to bromides that touch upon ingenuity, creativity and innovation but it is easy to forget that these essential qualities must be nurtured.
A solid investment environment depends on a strong and stable currency, restrained federal spending, less harmful legislation, dependable contract law, limits on taxation and countercyclical capital regulation.

In my humble view things, when looking around the corner, appear rather bleak.

Ritholtz, Ratigan Take on the 'Giant Vampire Squid'

It's rather remarkable that, in the past, so little attention has been drawn to this incestuous relationship that brings into question such fundamentals as integrity, principles of goverance, regulatory impartiality, separation of regulators from the regulated and conflict of interest.

Even at the risk of going "overboard" in attacking the unhealthy and impartial relationship between Washington and Goldman, it serves the larger public interest in bringing light to what is happening, the potential policy issues and the conflicts of interest. The frequently mentioned practice of placing Goldman alumni in high ranking positions at Treasury is perhaps the most central and disturbing issue.

And late last fall when Paulson was Treasury chief and with Kashkari overseeing TARP, a number of inherently political decisions were made in determining which, and to what extent, institutions would benefit from TARP. Bear Sterns and Lehman Brothers, large competitors of Goldman, were deemed not to be too big to fail.

This could not be lost on Kashkari or Paulson and it would have been better policy to prop up the other two rather than allowing them to fail and further concentrating the investment brokerage business in the hands of Goldman. Similarly, the two had to know that when monies were put into AIG some would accrue to the benefit of Goldman as AIG would be allowed to honor its CDS counter party risks.

These are but two examples of obvious conflict of interest that are part of an institutional relationship and how each was handled; both were handled in ways highly favorable to Goldman. The continuation of this privilege and obvious conflict of interest must be curtailed and one of the ways this can be done is by continuously reporting on the subject and bringing to light all of conflicts of interests and how....most usually....they are resolved in Goldman’s favor.

JPM and Maiden Lane: What the Fed Doesn't Want Us to Know

Good point Morph.

We have invested/committed $130 billion or so in AIG so taxpayers can help the Fed buy Maiden Lane at fair market value, help AIG cover CDS with Goldman and others, help AIG pay bonuses and realize yet undiscovered benefits.

Citi recently said that AIG faces additional CDS losses that could reduce equity to zero. Tongue in cheek, it would have been cheaper to pay too much for ML2 and ML3.

Goldman Sachs Backlash Is Picking Up Steam

I don't think Goldman should be penalized for making a good bet in a free market; the problem rests with the treatment of AIG, a company that repeatedly made bad bets on an insurance product.

I don't know where to what extent or where Goldman would have reported the $13 billion gain from AIG but it is reported Fixed Income, Currency and Commodities (FICC) was the key driver in the earnings surprise. The division’s revenues swung $10 billion qoq, to $6.6 billion from a negative $3.4 billion.

But notes indicate other divisions did not perform as well. Revenues fell 20-30% year over year in all other major business lines, such as equity trading, investment banking, asset management and securities services (prime brokerage).

Big Debt and Big Returns Could Be Spurring This Rally

Many of the companies with the highest debt structure are outpacing the market for the simple reason that investors believe Treasury, through CAP and the recently announced PPIP to purchase legacy assets and securities, will improve their debt and capital structure. In the eyes of some, they are not as bad as they look.

TARP: Bailout or Money Pit?

I think the problem is larger than money; I think the fundamental problem is that investors do not believe the administration has a viable plan to restore stability to the banking system and systematically deal with the core issues facing the sector.

Under both Bush and Obama, the TARP program has lacked clear goals, has been implemented in piece meal fashion and has suffered from lack of transparency. From the very beginning, the U.S. government made the mistake of addressing each major bank failure differently: aiding the takeover of Bear Sterns by JPMorgan, allowing Lehman Brothers to go bankrupt and then dumping $180 billion into AIG.

Under Geithner, there has been his underwhelming perfromance as a speaker and his inability to inspire confidence by communicating a thoughtful, comprehensive plan. Details of the stress test were slow to materialize and then there were the nagging questions of which capital ratios were to be used in guaging solvency. And there is the suggestion that purchases of preferred shares will be calibrated as losses occur.

Finally, when the government increased its stake in Citi to 36% and infused more capital into AIG, the markets took this to mean the problems are large, never ending and too big to be fixed. TARP has lost credibility with the market.

AIG: Bigger Loss, Bigger Bailout

There is a lot to this story but what is weighing on the market is that this is their third trip to the well and things don't look that much better.

Reasons for returning to the government for assistance include, among other things, an inability to sell premium financial assets and mounting losses from restructuring charges and writedowns related to commercial loan- backed securities and credit default swaps.

Both of these reasons.........inabil... to sell good financial assets and further writedowns on troubled assets........speaks volumes as to the deteriorating conditions in the credit markets.

Wall Street's New Math

I think Schiller's application of P/E ratios makes the most sense as he uses average earnings over the past ten years.

P/E ratios are just another tool in the kit a and do tend to be mean reverting.

The problem with them is that the P/E multiplier or ratio is highly sensitive to inflation, interest rates and expectations.

Bailout Accountability: Something's Rotten in the Treasury's Kingdom

This was discussed today in a similar post on SeekingAlpha.

It's painfully clear that more time and thought should have been invested in TARP before its approval and funding.

Treasury's original TARP goal included avoiding widespread, systemic failure. Something about protecting taxpayers and forestalling further foreclosures was added subsequently. While implied, there was nothing specifically mentioned about extending credit or making more loans available.

These goals were to be realized through direct purchase of troubled assets........somethin... early critics said would be difficult because of the time it would take to price the assets under consideration. And after securing approval to purchase troubled assets, Paulson switched gears and started buying preferred stock, attaching few strings along the way.

Characteristically, we are now examining what has taken place and are asking whether the public good has been served and where the money went. Sadly, we got pretty much what we bargained for.

We did not demand much in the way of accountability in use of the funds..........and, as the author points out, we are not getting much. In a similar vein, we did not specify that the TARP funds should be used as reserves for expansion of credit. And sure enough, no new loans.

These are getting to be expensive lessons and I hope something is learned in the process.

Government's Best Move in 2008? Letting Lehman Fail

A very interesting article that challenges our thinking; I think it will be debated for some time with little consensus.

My first thought, is that the current situation is a result of government failure to bring regulation to an increasingly complex financial services industry. Markets can only be efficient when there is transparency and the opaque industry of synthetic financial products, including credit default swaps, is anything but transparent. Thus, there are pricing issues and fear of counter party risk.

Had government performed its function of providing the infrasturcture needed for markets to operate efficently, it is unlikely that it would have had to place the GSE's under receivership and taken other steps mentioned in the article. Intervention was required because there was lack of anticipation.

The decision to allow Lehman fail is covered well in the article but was followed by unintended consequences. Fears immediately consolidated over the viability of AIG, Goldman and Morgan. And the government did not forsee the depreciation of Lehman's bonds leading to a run on money market deposits.

The take away is that the government's function should be to assist private enterprise by providing a regulatory environment that offers transparency and promotes efficiency. Direct intervention is a moral hazard and leads to unintended consequences.

Great Depression Not Imminent, But Inevitable

The above is an interesting article, offering fresh insight into the role that CDS have had in spurring lending and growth and the implications of repriced credit insurance. To suggest, though, that the present price and/or availability of CDS is the singular reason for a prospective depression is grossly over simplifying the horrendously complex economic problems the world is facing. And while many developments have led us to where we are today, the significance of the housing bubble.....in all of its dimensions... and its ongoing aftermath must be included in any discussion of today's financial Armageddon.