CautiousInvestor

Big Banks: The Consensus Is Cracking

I wish King had gone further and observed that most of the policies advocated by this administration are delusional: financial reform, healthcare reform, environmental reform and pending educational reform.

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.

New Era of Wall Street Wealth, In Part Courtesy of Washington D.C

This uniquely focused and distorted era of wealth is a product of misguided policies that have allowed a select few to prosper, made things worse for most, destabilized the economy and concentrated wealth in ever fewer hands. Failing to correct underlying problems or broadly stabilize the economy, government has made things worse by broadening gaping income disparities and (as noted by Washington's blog) by:

(1) Throwing trillions of dollars at the "too big to fails", instead of admitting that many of them are insolvent

(2) Undermining trust of nations all over the world in the American economy

(3) Failing to restore Glass-Steagall, reign in credit default swaps, or do anything else necessary to stabilize the financial system

(4) Attempting to restart high levels of leverage and securitization

(5) Failing to take real measures to decrease employment and increase manufacturing

(6) Creating an enormous debt overhang and trashing our currency

BofA and Stating the Obvious About Bank Profits

"Shown above are securitized AAA securities backed by 2007 vintage (that is, bottom of the barrel) subprime home-equity loans Why is their price so high? Because the Federal Reserve continues to buy huge amounts of mortgage backed securities, and because the Treasury and Fed are providing ultra-cheap, non-recourse financing for banks (through Public-Private Investment Partnerships) to buy these securities."
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We have socialized banking system losses through Fed purchases and there is now discussion of extending this program of purchases of MBS which will invariably leave the Fed with losses. ( no wonder they oppose an audit ) It's incredible the lengths we have gone to satisfy the demands of the banking oligarchy: TARP, accounting changes, payment of interest on reserves, a fraudulent bank examination disguised as a stress test, delays in financial reform, preservation of the too-big-to fail doctrine and allowing banks to recapitalize by renting Treasury's balance sheet under FDIC guarantees.

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.

Why Is Goldman a Bank Holding Company?

Andrew Sorkin does a good job of painting the turmoil roiling markets just before the decision to allow Goldman to become a bank holding company; there was a pervasive crisis of confidence marked by a rush for cash. After being approved as BHC Goldman had acces to liquidity provided by the New York Federal Reserve, received TARP monies and rented the Treasury's balance sheet through issuing debt with FDIC guarantees.

Your second question is perhaps more interesting:

-Why is Goldman Sachs allowed to maintain leverage ratios significantly higher than the large legacy bank holding companies like Wells Fargo, Bank of America (BAC), JPMorgan (JPM) and Citigroup (C)?

-Why is Goldman allowed to operate like a private equity company, holding large stakes of foreign non-financial corporations? (I should note that Financial Holding Companies do have ten years in which to sell their stakes)

-Why is Goldman (and other large banks) allowed to operate like a hedge fund and take outsized risks with capital via large proprietary trading operations. Most of Goldman’s profits are coming from this area. At least Deutsche Bank (DB) has offloaded these bets onto hedge funds in which it invests. Given the fact that the large too-bog-to-fail financial institutions have received a large backstop from the taxpayer, the fact that they are loading up in prop trading shows that regulation in the U.S. is non-existent.

-Why is Goldman allowed to have an interest in the failure of other financial firms? We now hear that Goldman has an interest in the failure of CIT (CIT), a major lender to small-and medium-sized businesses. These perverse incentives are everywhere in the derivatives world and were an enabler of the financial meltdown and the principal reason AIG was bailed out with taxpayer money.

I think the answer to that question lies in the dark corridors connecting Wall Street, Treasury and the Fed, whose identities are becoming increasingly blurred. It is also seen in the unwillingness to (1) institute meaningful financial reform, (2) reinstate Glass Stegall and (3) abolish the too big to fail doctrine.

Too Big to Fail - Everyone but Washington Knows What Needs to be Done

Jamie Dimon is being a bit disingenuous when presssing for resolution authority to wind down a massive bank holding company when twenty five or so holding companies, including JP Morgan, have been deemed systemically vital and too big to fail. Plus, to wind down a large holding company with international operations is a beast of another color. If the resolution is passed, its significance will be largely symbolic. Curbing casino activities, however, along with other measures is real reform.

The Coming Consequences of Banking Fraud

If we look back at recent economic history and look for bubbles that have imploded, we quickly come upon the S&L crisis, the commercial property bubble (Japan), the emerging market bubble (we helped fuel it), the dot.com bubble and most recently the housing crisis.

In each case, successive bubbles were fostered through irresponsibly loose monetary policy that distorts normal market signals, encouraging speculation and consumption. And in each case the bubbles collapsed through tightening of credit to address imbalances and speculative excesses but well after the fact.

The Japanese experience is eerily similar to our recent crisis as that it was brought on by a high rate of domestic savings (we had China) easy money, loose oversight, an influential cartel and lax underwrting standards. Their response was to raise interest rates and then lower them when the scope of damage became apparent; the stock market cratered as did commercial and residential real estate prices.

The Japanese economy stagnated for the next decade and for a variety of reasons, including demographics and aging population, it is only a shadow of its former self. Most of this is a result of a farrago of poor policy responses to the crisis and a stubborn unwillingness to force the zombie banks to writedown indisputably bad assets.

Despite our unwillingness to force the banks to writedown bad assets, the unprecedented scale and scope (global) of current monetary and fiscal policy clearly has the potential to create the next bubble and I believe it will. Understanding that the effects of our monetary policy is not restricted to our shores, the massive injections of liquidity do not have to remain within the US and will trickle towards the next puddle of speculative excess.

If I am correct in where I think it will be.....and its just speculation on my part though alarm bells have already been heard.....it will be a big one. But that's part of the process; each bubble gets bigger, each inflicts ever more damage and each new bubble requires ever greater amounts of liquidity.

Bailouts: Revisionist History

While I prefer some of the more extreme measures, maybe Treasury could have engaged in some long-term planning(several forward looking weeks) by making CAP (TARP) monies available simultaneously with a hastened version of the soap opera viewed on CNBC as the stress test. Instead,we gave them the money only wind up negotiating with the oligarchs after we had given away the store. As to the underlying financial soundness of the program it is not profoundly shocking the most credit worthy institutions with the best business models were the first to repay CAP monies. Before we break out the bottles, lets see what happens with GM, Chrysler, AIG, the agencies and other black holes.

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.

Bernanke Has His Hands Full, Again

I've commented on Bernanke over the past days and SA readers are aware from my remarks that I believe Bernanke and Greenspan are the principal architects of the financial crisis and where we stand today.

Much of what you describe as improvement, stems from massive, unprecedented and globally coordinated fiscal and monetary policy responses to the financial crisis. The most difficult task for all of us is to see where these policy responses end and the beginnings of real recovery begin. Cash for clunkers is not a defining moment.

Among the challenges facing Bernanke, you fail to mention two hurdles that..... more than anything else.... will determine his effectivenes and legacy during the next four years. First, and assuming the economy gains real traction, will Bernanke will take the esseential steps to unwind the Fed balance sheet and contain bank lending if unemployment remains stubborningly high? In congressional testimony he laid out the various options through which to mop-up excess liquidity but will he follow through at the time it is needed?

And secondly, and you touched upon this, what will his official position be if Treasury runs into trouble borrowing the monies needed to feed the voracious spending appetites of Washington?
The Fed was given independence to remain free of undue political influence and pressure with one of the pressure points being to monetize debt when there are no other alternatives. Looking forward and seeing trillion dollar holes and avalaches of pending debt, it may be hard to finance these amounts under the best of circumstances but impossible if the dollar goes down the shitter. If Treasury auctions fail, what will Bernanke do?

Key Factors Driving the Market

While not disagreeing with anything said, what I have observed is broad, alternating themes of (1) reflation which is accompanied by strength in commodities and equities and (2) deflation which is accompanied by strength in the dollar and US Treasuries.

These relationships can be see here:

stockcharts.com/charts...

Paulson Owes Bank of America's Shareholders a Better Explanation

A tangent on this discussion is the related issue of transparency.

When Treasury, FDIC and the Fed made a decidion to release stress test outcomes at the bank level they made much of the benefit of transparency.

From the May 7, 2009 Treasury release: Greater disclosure will help improve confidence. "Today’s results should make it easier for investors to evaluate risk and to differentiate across institutions. The stress test will help replace the cloud of uncertainty hanging over our banking system with an unprecedented level of transparency and clarity. This is important, as markets work best when they have full access to the information on which to make informed investment decisions. With better disclosure, private capital is more likely to flow into the financial system, which will accelerate the point at which banks can replace the government’s investments."

Days later, Bank of America and the Fed and OCC entered into a Memorandum of Understanding, the shortest of regulatory short leashes and a virtual choke chain. It imposes deadlines for meeting specific goals over the next few months.

Citi also entered in a MOU with the OCC, with both firms having to improve goverance, overhaul their respective boards and address perceived asset and liquidity risks.

What bothers is not that agreement was entered into but that they, as customary, kept the MOU secret while boasting that the world is now more transparent. It's both inconsistent, if not contradictory, for the administration to argue and make all kinds of noise about the benefits of transparency and then enter into secret regulatory understandings out of fears such “informal actions” will stoke investors’ fears and bring about market instability.

In my view, the MOU of understanding should have been incorporated into the stress test results and released concurrently to provide complete transparency to the capital markets.

BofA, Citi: Where's the Transparency?

This administration is easily the most immoral and patently corrupt group political thugs to ever seize power: firing Wagner, threatening Lewis, favoring unions, rigging markets, funding AIG to allow them to unwind CDS's with Goldman, pressuring congress to pass transformative legislation never read, pursuing reckless fiscal policy and constantly cutting deals behind closed doors.

The whole essence of stress testing was to provide market transparency but, as we quickly learned, transparency can be transparently opaque. We were never made privy to the capital metric but we eventually learned that it was changed, at the behest of the banks, at the last minute and many banks negotiated down their mandated capital buffers. Along with favorable accounting changes, this allowed banks to report record earnings and suck capital from a clueless, hapless market.

As it is used today, the word transparency is nothing more than a platitude if not a shibboleth.

Meredith Whitney Ratings

As I posted elsewhere today, I believe her sentiment towards Goldman is being driven by a belief that it will profit from the avalanche of debt to be issued by all levels of government.

From your chart it is easy to see she expects earnings of $3.62 from the eight banks she covers versus the consensus of $2.95; compared to the consensus, she expects Goldman to earn $1.00 more than the median estimate while she expects the other seven
to earn $.33 less. All in all she's hardly gushing over the sector, something reflected in her estimates and ratings.

In my eyes, she's making a big call on Goldman by going way outside of the envelop, a call I doubt she would make unless confident of her instincts. With much prestige and credibility at stake, if proven correct she will retain her status as a very savvy banking analyst capable of seeing what eludes others.