FedUpUSA

Archive for April 12th, 2010

“Banking System Still Quietly Insolvent” ; Larry Summers’ Imagination Reaches Escape Velocity

Inquiring minds are reading an excellent post by John Hussman about Stock Market Valuations, Extend and Pretend Banking, Public Policy on Housing Bailouts, and Solvency of the Banking System. Here are a few snips from Extend and Pretend.

Over the past 12 years or so, I’ve been repeatedly astonished at the tendency of investors to do things that they should have known to avoid simply with the use of a calculator and basic arithmetic. We’ve used numerous metrics during this period to show that the estimation of long-term market returns (7-10 years and beyond) doesn’t require calculus or statistics, but fairly direct methods to normalize earnings, plus a bit of arithmetic. Rich valuations are predictably followed by sub-par returns. As a result, investors have earned an average annual total return of just 2.4% in the S&P 500 over the past 12 years, while enduring two separate instances where they have lost about half of their money as part of the ride. Essentially, we have gone nowhere in an interesting way. At present, investors have priced the market at a level that makes a continuation of this experience likely for several years to come.

As of last week, the S&P 500 remained strenuously overvalued on the basis of normalized fundamentals. From that perspective, even if the trough we observed in March 2009 was the ultimate price low of the secular bear market since 2000, it’s not likely to represent the ultimate valuation trough. Given the current state of valuations, and the likelihood of several years of additional credit deleveraging, it seems that economic conditions, valuations, and the typical duration of secular bear markets converge on the likelihood of several more years of interesting but unrewarding market volatility. Secular bull market periods tend to begin with quite low multiples to normalized earnings (historically, on the order of 7), which is what provides the platform for a very long period of subsequent gains.

Extend and Pretend

With regard to credit conditions, the U.S. financial system continues to pursue a strategy of “extend and pretend.” … The impact of “extend and pretend” is to create a gap between the reported value of assets and the value they would have on the basis of the cash flows that those assets can reasonably be expected to generate over their maturity.

Moreover, regulatory changes over the past year have affected what actually gets reported as “troubled.” As the New York Times recently observed, ” A bank owed, say, $4 million on a property now worth $3 million would previously have had to classify the entire loan as troubled. Now it can do that to the $1 million difference only.”

As for policy efforts to reduce delinquencies, I’ve long argued that it is a bad idea for policy makers to announce delinquency prevention plans that have, as their centerpiece, publicly subsidized reductions in mortgage principal. It’s one thing to extend the loan in a way that preserves its present value, by swapping a claim on future appreciation in return for principal reduction, but it’s quite another to offer to cut the principal outright. The reason is that instead of confining the assistance to presently troubled borrowers, you create a whole new set of borrowers who then choose to be troubled in order to get the assistance. According to a University of Chicago study, “strategic defaults” – where people choose to default on their mortgages even though they can afford to pay – accounted for 35% of all residential defaults in December 2009, up from 23% in March 2009. Offering public subsidies for this behavior, when too many homeowners are already legitimately struggling, does not smack of a bright idea.

The real concern from my perspective remains the potential for a second wave of delinquencies beginning in data as of the first quarter of 2010 and extending well into 2011. …

In short, my impression is that investors are deluding themselves about the solvency of the banking system. People learned in the 1930′s that when you don’t require the reported value of assets to have a clear and tangible link to the value that the assets would have in liquidation, bad things happen. Yet this is what regulatory and accounting rules are allowing for the banking system at present. While I do believe that bank depositors are safe to the extent of FDIC guarantees, my impression is that the banking system is still quietly insolvent.

There is much more in the article including a series of charts on bank loans, real estate loans, and credit card loans.

Global Banking System Extend and Pretend Insolvency

I happen to agree with John Hussman on all points mentioned. Moreover, it is not just the U.S. banking system that is insolvent, the global banking system is nothing but a giant extend and pretend operation including the PIIGS (Portugal, Ireland, Italy, Greece, Spain), China, the UK, and even Canada as soon Canada’s gigantic housing bubble crashes.

Just as U.S. housing policy encourages more walk-aways, the EU’s subsidized loans to Greece (See Grecian Formula 16 Now On Sale) practically guarantees the EU will need to offer the same deal to Spain and Portugal at a minimum.

Note too, that European banks have their own extend and pretend game going in regards to loans based in Euros to the Baltic states. Those loans cannot possibly be paid back.

George Soros is talking about a pound devaluation for the U.K. Please see Former Fed Gov. Poole Blasts Fed’s Favoritism; Soros Bought More Gold, Says Pound Devaluation is Option for details.

Canada did not avoid a crisis because their banks were better or smarter or used less leverage. Canada avoided a crisis because for whatever reason, their housing bubble did not yet blow sky high. However it will, and Canada’s banking crisis is yet to come.

To understand why, please see California USA vs. Ontario Canada – Which State (Province) Is In Worse Shape? Canadian Banks vs. US Banks Comparison.

There are so many reports on bubbles in China that I hardly know where to begin. Here are a couple of them. GMO has a white paper on 10 Signs of Speculative Mania in China. In response to that paper, please consider an Email from a Chinese on China’s Real Estate Bubble.

Finally, in the US, please consider an interactive map of the $3+ trillion public pension plan deficit, state by state: Interactive Map of Public Pension Plans; How Badly Underfunded are the Plans in Your State?

In short, consumer and bank debt simply cannot be paid back in a global wage arbitrage economy, with massive consumer and corporate debt and no source of jobs.

Escape Velocity

Amazingly, Larry Summers says that problems with healthcare, education, and even long term fiscal deficits are being addressed. That is proof economists are starting to believe their own nonsense on extend and pretend.

“I think the economy appears to be moving towards escape velocity.” said Summers.

One thing that has reached escape velocity is Larry Summers’ imagination.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

SP Futures Reach Apex of Fraud As Earnings Season Arrives and Bank Accounting Dodgy as Ever, Doing God’s Work

“At what point shall we expect the approach of danger? By what means shall we fortify against it? Shall we expect some transatlantic military giant, to step the Ocean, and crush us at a blow?

Never! All the armies of Europe, Asia and Africa combined, with all the treasure of the earth in their military chest; with a Bonaparte for a commander, could not by force, take a drink from the Ohio, or make a track on the Blue Ridge, in a trial of a thousand years.

At what point, then, is the approach of danger to be expected? I answer, if it ever reach us it must spring up amongst us. It cannot come from abroad. If destruction be our lot, we must ourselves be its author and finisher. As a nation of freemen, we must live through all time, or die by suicide.” Abraham Lincoln 

Earnings season begins again this week in the States.

Investors remain skittish despite rosy predictions for earnings. This may be because of the suspicion that there are continuing misrepresentations of the true financial picture being permitted by the regulators, the ratings agencies, and the accountants.

For example, Bloomberg reports that if Bank of America Corp., JPMorgan Chase & Co. and Wells Fargo were taking the appropriate reserves against loan losses, it would virtually wipe out all their expected profits for 2010. And I suggest that this loss estimate is likely to be conservative. But of course this is not going to happen in the land of ‘extend and pretend.’

Reserves against losses? We don’t need no stinking reserve, not while we have the Federal Reserve.

So don’t get all short this market just yet, and provide grist for the mill as it might just grind higher. The good guys don’t win until they get on their horses and do something. Wait for a key breakdown, probably triggered by some disclosures.

Misrepresentation of the facts and figures abounds. Through the years I noticed a common denominator amongst the kleptocracy and slippery sons of privilege: when the going gets tough, they cheat, even more than usual. And they become righteously indignant if you call them on it. As one pampered son said to me, “If the professors are not smart enough to stop me, why should you care?”

That is how they got through university, and how they get through life. They cheat on their taxes, on their wives, their community, their civic obligations, their business dealings, their friends, and even themselves. And they spend a lot of time and money stuffing the hole in their being with possessions, both things and people, to create the illusion of substance and self-worth. And so often they have learned this from their parents either through abuse or example. There must surely be a special place in hell for anyone who twists such a pathetic half-life out of the gift of a child.

Someone sent me the series currently playing on HBO, “The Pacific.” They knew I would be interested because my father was one of those kids who, right after high school graduation, took their first trip away from home, from Cherry Point to Tokyo via hell. Its a brutal series, but worth watching if you want a less romanticized version of what war is like, without the self-indulgence excess of the anti-war movies. I enjoyed the exposure they give to John Basilone, the only NCO to win both the Medal of Honor, and the Navy Cross posthumously, in WWII. I used to attend the church in his hometown of Raritan, NJ where they still have a parade in his memory every year.

That experience and the Great Depression made all our fathers and uncles as tough as nails, reminiscent of the character in the movie Gran Torino. My father wasn’t pretty. He was rather rough around the edges with a hard shell, did not suffer fools gladly, and had a truly remarkable command of rough language, as I understand is the custom among Marine Corps sergeants. But he always stood his ground, and did the right thing even when it hurt, out of a sense of duty, honor and pride. And he made sure that I knew that being honest, and honorable and truthful was the right thing, the only thing, to do. And I thank him for it. I am glad he is no longer around to see this triumph of the privileged, and the submission of the many, in a country that he loved. Semper Fi, dad.

Bloomberg
Bank Profits Dimmed by Prospect of Home-Equity Losses
By Dakin Campbell and David Henry

April 12 (Bloomberg) — Bank of America Corp., JPMorgan Chase & Co. and Wells Fargo & Co. may have to set aside an additional $30 billion to cover possible losses on home-equity loans, an amount almost equal to analysts’ estimates of profit at the three banks this year.

The cost of these reserves was calculated by CreditSights Inc., a New York-based research firm whose prediction almost four years ago proved prescient after banks reported unprecedented mortgage-related writedowns. Recognizing the home- equity loan losses is unfinished business from the housing bubble, CreditSights said in a March 29 report.

Potential writedowns on the loans are casting a shadow over earnings, as analysts try to determine how much, and how quickly, loan-loss expenses will decline from the industrywide peak reached in June 2009. Banks led by New York-based JPMorgan begin reporting first-quarter results this week….