FedUpUSA

Archive for January 13th, 2010

How Do You Plan To Pay For This?

Posted by Karl Denninger

The numbers are now in on the first fiscal quarter for 2010, and it’s ugly.

Truth Peeks Out From Under The Blanket

Posted by Karl Denninger

Gee, you think?

If Government Won’t Break Up the Giant Banks, Let’s Do It Ourselves

Submitted by George Washington

As everyone knows, the economy cannot permanently recover and truly stabilize until the giant banks are broken up. The top independent experts agree that the “too big to fails” are a drain on the economy and put the entire system at risk.

The giant banks aren’t lending much to the people who need it. Fortune pointed out in February that smaller banks are stepping in to fill the lending void left by the giant banks’ current hesitancy to make loans. Indeed, the article points out that the only reason that smaller banks haven’t been able to expand and thrive is that the too-big-to-fails have decreased competition.

Federal Reserve Governor Daniel K. Tarullo said in June:

The importance of traditional financial intermediation services, and hence of the smaller banks that typically specialize in providing those services, tends to increase during times of financial stress. Indeed, the crisis has highlighted the important continuing role of community banks…

For example, while the number of credit unions has declined by 42 percent since 1989, credit union deposits have more than quadrupled, and credit unions have increased their share of national deposits from 4.7 percent to 8.5 percent. In addition, some credit unions have shifted from the traditional membership based on a common interest to membership that encompasses anyone who lives or works within one or more local banking markets. In the last few years, some credit unions have also moved beyond their traditional focus on consumer services to provide services to small businesses, increasing the extent to which they compete with community banks.

But the government – instead of breaking up the giant banks who aren’t lending to the people who need loans – is trying to prop them up using permanent bailouts. See this, this, this and this.

And – instead of separating different business activities (such as depository banking functions and speculative investments) – the government is actually allowing companies to get involved in a wider variety of business activities.

For example, economist Simon Johnson points out that Goldman Sachs recently converted to a “financial holding company”, allowing Goldman to borrow money from the Fed at essentially no cost, and then invest it in any thing it wants. Johnson gives an example: Goldman bought a large share of the stock of a Chinese automaker. If the investment succeeds, Goldman will reap the profits. If it fails, the American taxpayers are on the hook.

And Goldman is apparently profiting from its combination of roles as both an investment brokerage house for other investors and as a large speculative investor itself. Specifically, Goldman apparently delays trades it makes for its clients long enough to use that inside knowledge of who is buying or selling what to make speculative investments for itself, oftentimes taking the exact opposite position for itself and its largest clients as the position it is recommending to its Mom and Pop investor clients.

Why are politicians letting this happen?

Could it be because the giant banks have bought and paid for Congress and the White House? See this, this and this.

We’ll Have to Do It Ourselves

If the government isn’t doing anything to fix this dangerous situation, we’ll have to do it ourselves.

As a start, if Congress won’t reimplement the Glass-Steagall Act (the Depression-era law which previously separated depository functions from speculative investing), let’s manually separate these two types of businesses.

How?

Simple: let’s pull our money out of the too big to fails and put it into small community banks and credit unions.

The giant banks may still make bucketloads of cash on their casino style speculative gambling (for now, at least), but after we’ve moved our deposits to more responsible, smaller banks which don’t gamble as much, then we will have manually separated depository banking functions from the giant banks’ speculative investing.

Get it?

The government isn’t doing the job and fixing the problems which have led to the economic crisis … so we’ll have to do it ourselves.

Note: Some people say that moving our money out of the too big to fails will just mean that the government will give them more bailouts. But this misses 3 points:

1. If the deposits are withdrawn, the giant banks will only be speculative gamblers, and at least our deposits will be safe and won’t be mixed with their toxic assets
2. The giant banks and their enablers in Washington will look even worse if they are bailing out companies that are solely and obviously gambling casinos
3. The head of the International Monetary Fund, Dominique Strauss-Kahn, has warned:
   

   The public will not bail out the financial services sector for a second time if another global crisis blows up in four or five years time, the managing-director of the International Monetary Fund warned this morning.Dominique Strauss-Kahn told the CBI annual conference of business leaders that another huge call on public finances by the financial services sector would not be tolerated by the “man in the street” and could even threaten democracy.

   “Most advanced economies will not accept any more [bailouts]…The political reaction will be very strong, putting some democracies at risk,” he told delegates.

In other words, the government – fearing revolt – might be more hesitant to give another round of bailouts than people assume.

I’m not looking at this with rose-colored glasses, and I realize that the TBTFs will act like the kid who killed his parents and then cries for pity since he’s an orphan.

But I think that if the government is not doing its job, we should do it ourselves, and that a focused gesture of taking things into our own hands can only help.

CLSA’s Mike Mayo Discusses A Financial Industry On Steroids, Lays Out The 10 Main Problems With Banks

Submitted by Tyler Durden

Mike Mayo lays out the ten main problems with the financial industry:

One – enhanced performance with excessive loan growth: Banks and the financial industry in general grew loans twice as fast as the natural rate, approaching 8% or about 10% or more adjusting for securitization (pre-crisis), above nominal GDP of 5%. We – consensus – strongly believed that nominal GDP would slow for the past decade, but banks still pushed for loans that should never have been made. This difference is even greater after adjusting for securitization of loans, or when banks packaged and sold loans, often with little if any “skin in the game” with regard to the loan’s performance.

Two – pumped up profits with higher yielding assets: Higher yields means higher interest rates and – for banks – higher interest rates mean higher profits. To pick two higher risk loan categories, for the last decade, banks had over 20% average annual loan growth in home equity and over 15% average annual growth in construction loans, areas with higher than typical yields. In securities, banks reduced the percentage of low yielding treasuries from 32% in the early 1990s to under 2% in favor of more risky securities. In the extreme, the ability of a bank to make higher profits in the short-term is as easy as making a phone call. The issue is that higher yields get realized immediately but it comes with higher risk that gets paid later.

Three – side effects ignored with concentration of assets: The rush in real estate was no secret. Of the 11 loan categories listed by the FDIC, all five of the fastest growing loan categories were real estate related. This is as simple as the old banking adage, “if it grows like a weed, maybe it is a weed” or, perhaps more generally, “don’t put all your eggs in one basket”.

Four – higher dosage with higher balance sheet leverage at banks and brokers. By 2006 – before the problems hit the industry – U.S. banks had the highest level of leverage in a quarter of a century. There are many ways to look at this, but I took tangible capital and reserves for loan losses (source: FDIC). This data was also not a secret since the data comes directly from bank regulators. Similarly, leverage in the brokerage industry steadily increased from 20x in the 1980s to 30x in the 1990s to almost 40x in the past decade until shortly before the crisis (source: SIFMA).

Five – investment banks originated more exotic dosages. By this, I mean instruments such as CDOs, CDOs-squared, etc. that amplified leverage in new and untested forms. It is always hard for us analysts to know what type of risk banks have on their balance sheet. These forms were so complex that not even CEOs, directors, and auditors fully understood their risks. As a reminder, some of these products were created by experts with Phd’s in mathematics. This type of complexity is often used as a reason to pay people massive salaries. The argument goes that if you don’t pay the salaries, good people will go elsewhere in the economy. Isn’t that a good thing? The exotic securities are a clear example of several where Wall Street needs to shrink in importance. The protection from monoline insurers also proved much less than met the eye. Innovation often outpaces regulation, but in this case it was more than usual.

Six – consumers went along for the ride. Consumer debt to GDP has reached a record level of 100%, versus only 50% 25 years ago. This leveraging created a false illusion of prosperity that allowed for the purchase of homes, cars, and other items, many of which should have never been financed and purchased. It is no secret that everyone from kids, pets, and dead people received solicitations for loans.

Seven – accountants assisted with performance enhancement. In 1998, the SEC required banks to move closer to a pay-as-you-go approach when accounting for losses on their loans. This was wrong. The result was that banks made more risky loans with better profits but set aside even less reserves for future problems. The banking industry saw a steady decline in reserves for problem loans from the time of the decision in 1998. The move by the SEC was well intentioned since it came at a time of concern about “cookie jar reserves” but misguided since it failed to reflect the unique situation related to banks when it comes to conservatism and reserving for future loan problems. This is only one of several accounting examples.

Eight – regulators facilitated performance enhancement. Banks pay insurance premiums for the coverage that they give on deposits at banks. Banks have paid this fee since the FDIC was established after the Great Depression. Yet, banks paid zero deposit insurance for the decade ending 2006 because the insurance fund was deemed fine. This was a ridiculous insurance model that is analogous to an auto insurance company not charging premiums until somebody has an accident or a life insurance company not charging premiums until somebody dies.

Nine – the government doled out some of these steroids. GSE’s and their role in the mortgage market helped to accelerate the growth in housing related securities via subsidies to banks and consumers whose absence would have meant less of a housing bubble. The government created more of a commandeconomy model that had the effect of allocating an excessive amount of
capital to the housing sector.

Ten – incentives encouraged the behavior. To still further the analogy, the system shunted the “doctors”, that is, those whose job it is to report on the financial health of companies and the industry, in lieu of those with more positive outlooks. Compensation of banks steadily tracked revenues for all of last decade. The problem is that compensation only tracked profits until losses increased later in the decade, highlighting that prior compensation was far above normal after incorporating losses that were attributable to prior year revenues. I saw issues first hand. First, in the past decade (2000-2008), the stocks in the bank index (“BKX”) declined by over 40% but industry compensation failed to decline in a similar amount. Yet, when I wrote about compensation issues a decade ago, the reaction about me was that these issues were none of my business3. Second, only 7 months after I testified to Congress in 2002 about the backlash against analysts who provide unflattering research, I faced what I saw as backlash by a large bank against me and my critical views when I had lack of management access similar to others. It reached a point where I put a disclaimer about this lack of access in my research reports. My point is that if I face a backlash even after I testify to Congress on backlashes, how can a loan officer who is under pressure to produce loans realistically say “Maybe we should sell less loans?” and keep their job.

Mayo’s full testimony and powerpoint presentation

Treasury pegs U.S. deficit at $91.8 billion for December

Year-to-date deficit stands at $388.5 billion; string of deficits reaches 15 months

By Robert Schroeder, MarketWatch

WASHINGTON (MarketWatch) — The U.S. government ran a budget deficit of $91.8 billion in December, marking the 15th straight month in which outlays exceeded receipts, the Treasury Department reported Wednesday.

The December figures bring to $388.5 billion the deficit for the first three months of Washington’s 2010 fiscal year.

That’s on top of a staggering $1.4 trillion budget shortfall for fiscal 2009, more than three times the size of the deficit that the government ran in 2008.

The federal deficit for December 2008 was $51.7 billion.

With President Barack Obama under increasing pressure to cut the deficit, the White House is scheduled to unveil his budget for fiscal 2011 next month.

Among other things, Obama is considering charging banks a fee to recoup taxpayer funds used to bail out the financial industry. That money could be used to help pay down the deficit.

The government was still spending money in December to bail out banks, but not nearly as much as a year earlier. A total of $3.9 billion was spent on the Troubled Asset Relief Program last month, the figures showed.

Receipts were $219 billion in December, the Treasury reported, while outlays were $311 billion.

A year ago in December, receipts were $238 billion. Outlays were $289.5 billion.

With U.S. unemployment stuck at 10%, Obama also must contend with a growing chorus of calls to create jobs — but without adding to the deficit. Unemployment is shaping up as a key issue for voters as lawmakers prepare for mid-term congressional elections in November.

Earlier this month, the Congressional Budget Office estimated that the December deficit would come in at $92 billion. The nonpartisan agency also estimated that the deficit was about $390 billion for the first quarter of fiscal 2010. Read CBO monthly budget review.

The federal government’s fiscal 2011 starts on Oct. 1.

Robert Schroeder is a reporter for MarketWatch in Washington.