Archive for August 10th, 2011
From CNN Money:
Taxpayer-owned Fannie Mae just bought the servicing rights to a bunch of bad loans from the struggling Bank of America. Where does it end?
By Abigail Field, contributor
FORTUNE — Taxpayers may not realize it, but they just bailed out Bank of America again, this time to the tune of more than a half billion dollars.
The Charlotte, NC-based bank was one of the biggest recipients of bailout funds during the financial crisis. But Bank of America (BAC) continues to face deep problems related to its troubled mortgage portfolio and investors have battered the stock, which has plunged over 40% so far this year. That’s escalated concerns that the bank may need to raise more capital. Yves Smith at Naked Capitalism has even started a BofA death watch.
But apparently the federal government is determined to resurrect BofA: the Wall Street Journal reports the feds have just used Fannie Mae, which is controlled by the U.S. government, to infuse BofA with $500 million and ease one of the bank’s biggest headaches.
Yesterday afternoon on CNBC, Bank of America CEO Brian Moynihan mentioned that five of BofA’s six businesses were making money. The one black spot was its massive portfolio of problematic mortgages and the liabilities flowing from it. Moynihan also mentioned that BofA had just sold some “mortgage servicing rights” as part of its balance sheet strengthening efforts, but he didn’t elaborate.
According to the WSJ, Fannie Mae spent $500 million to buy the servicing rights to a big chunk of the “seven million loans still causing the most problems.” Although the $500 million is a paper loss to BofA, in that the rights were “originally worth more,” it looks like BofA is still getting a good deal because the portfolio’s “value is expected to deteriorate further.”
In fact, the deal is worth much more than $500 million to BofA, because getting rid of those servicing rights lifts a huge cost burden off BofA’s shoulders. And if securitized loans are involved, which they most likely are, the sale also limits the BofA’s potential liability to investors for its current servicing violations. Finally, the $500 million is surely more than the servicing rights are worth in an arms-length transaction. How do we know? Beyond the comment that the loans are expected to “deteriorate further,” the goal of the intervention can only be to fix Bank of America’s capital structure, which is easier for the government to do if it overpays for the rights.
In short, purchasing these servicing rights was another Troubled Asset Relief Program.
I’m sure this has nothing to do with their stock chart looking like this…and that they might be having capital raising issues.
Do you know where YOUR deposits are?
Just so all of you are clear: Bank of America just got over $500 Million in taxpayer money, but in just a few days, the “Supercommittee” of Congress is going to convene so it can raise your taxes and cut inconsequential things like Social Security, Medicare and Unemployment benefits. No, no. We can’t afford those. We can only afford to keep giving money to the insolvent banking institutions so they can also keep handing out money to bankroll political campaigns. YOU ARE MEANINGLESS!
ARE YOU GETTING THE PICTURE YET? Now maybe you can understand what has been going on in London.
One has to wonder after yesterday’s Fed statement and the screaming harpy nonsense out of the Democrat party.
First, let’s talk a bit more about that Fed Statement. The Federal Reserve has stated that their base case is now for zero to negative economic growth for the next two years. This is the only justification for zero interest rates; ergo, you just heard their forecast through their actions.
Next, you’re seeing the impact of fiscal consolidation in Greece. We had better learn from this as it’s coming here. Their “fiscal consolidation” is leading (temporarily) to lower revenue (taxes), exactly as one would expect. Why? Because when you make the necessary reforms you crimp profits which in turn crimps taxes, since taxes are assessed on earnings (either personally or corporately.) Therefore when you make the necessary changes to a bloated government that is deficit spending tax receipts always decline in the short term. Greece’s deficit widened as a consequence, and will for some time.
So will ours, if and when we take our necessary fiscal medicine.
Third, we better learn from Great Britain. Rioting has gone on now for four nights. Why? Price increases on necessary commodities coupled with the loss of legitimacy of government. The latter is extremely dangerous and it’s very real – including here. A new Rasmussen poll says that just 17% of likely US voters believe the federal government has the consent of the governed. This is down from 24% in May to the lowest level measured yet.
I don’t know what you can possibly say that’s positive about that. Further, only eight percent of Americans believe that their Congressman (or woman) listens to the voters as opposed to “party leaders.” And only six percent rate Congress’ job performance as “good” or “excellent.” These are numbers best-associated with monarchies or governments about to be beset by actual revolution, not functional representative republics.
Folks the fact is that we – collectively – blew it. Our representatives and other members of government listened to the “Captains of Wall Street” instead of their constituents – and mathematics. Instead of forcing those who did imprudent things – both borrowers and lenders – to eat their own cooking and blow up, we bailed them out and then went even further in that we did not force them to change their bad behavior. In fact we not only ratified that bad behavior we enhanced it by formally permitted “mark to fantasy” as a business practice on bank balance sheets.
This is a convenient fantasy but that’s all it is: A fantasy.
Eventually the cash flow always wins, because you can’t spend anything other than cash. This presents a huge problem in that the lack of real cash flow forces people to start kiting checks and otherwise scrounging in the couch cushions for pennies, along with pledging worthless assets for yet more lent money. Since the private economy has no real borrowing capacity left this ultimately winds up back on the sovereign balance sheet, which would be ok if there was tax revenue to support it.
But of course there’s not, because as unemployment goes up tax receipts go down.
This morning we’re back to insane volatility, this time downwards. Since the close yesterday we’ve seen a 30 handle range in the S&P 500 – a nearly 3% move. The Dow futures are down 200 after being up about 60 early in the evening last night.
The BS over in Europe hasn’t been fixed and can’t be without recognizing the frauds and resolving them. Unicredit and SocGen are again front-and-center and despite The Fed’s proclamation no government in the western world – not ours, not in Europe – has forced their banks to come clean and clear out their trash.
I hope you enjoy the markets over the coming weeks and months. You’ve already had your 401k and IRA trashed in the last two weeks and now we’re at it again – if you bought back into the huge ramp in the last hour of yesterday much of those gains are now gone and we’re headed for the toilet – again – this morning. Rumors will dominate and huge moves are now commonplace. This is unlikely to be over – not today, not next week, and not next month – until the stupidity by governments end.
Who knows where this ends, or if it ends before the people force it to end through either general strikes and destroying the government’s ability to collect taxes or even more-destructive acts.
All I do know is that there are times when one should step back and be prepared to fend for themselves rather than “believe”, and this is one of those times. We need leadership in Washington DC that will look at the fundamental mathematics and force those facts front and center into the debate, refusing to bend and demanding that all who come with any sort of solution or policy recommendation square them against the fundamental mathematical fact that debt cannot grow faster than productive output on a sustained basis.
There’s more than thirty years of hard mathematical fact that all economic policies of the last 30 years in this country, irrespective of party, has in fact devolved into an utter mathematical impossibility when one considers the longer-run future.
This organized fraud upon the public by both political parties and their minions must end right now.
We are in the end stages of this Ponzi Scheme and are teetering on the edge of full-on collapse. If immediate action is not taken to stop the accumulation of yet more debt and piling up of more leverage upon that which cannot be paid we will go down the toilet.
It may be too late even now, but this much is certain: The path we are on leads to CERTAIN disaster.
“With all the mess going on at the moment, I thought it was worth while stepping back a little and trying to look at the bigger picture.” So begins Andy Lees’ latest must read letter to clients whch explains succinctly virtually the entire story of where we were, how we got to where are now, how the current trajectory is unsustainable, why due to decades of capital misallocation anything that the Fed does now is essentially irrelevant, why our untenable debt pile does nothing but perpetuate an unsustainable ponzi scheme which will result in an unseen explosion in the true cost of capital: gold, and why the bond market will eventually, and inevitably, force an epic repricing in the cost of non-gold capital absent the arrival of the deux ex machina of real, actionable innovation that the Fed, and all global central planners, keep hoping for. Because the longer we keep plugging away with that worthless substitute, financial innovation, which is anything but, the greater the final collapse.
Andy’s conclusion: “Until the debt is cleared and capital starts to be properly allocated, economic growth per unit of additional debt will continue to sour. Until we get some real breakthrough technology, requiring large amounts of capital to both innovate and then roll out, we have no chance of supporting the economy.” Too bad than that this absolutely spot on observation reflect precisely the opposite of what the Fed is pursuing. Which is why, all else equal, and it will be unless the Fed is finally eliminated from existence, America, and the entire western way of life, is doomed… But don’t take our word for it. Here is Andy.
Why are we here: simple – years of central planning resulting in the greatest experiment in capital misallocation in history.
We are in this mess because of excessive leverage and excessive consumption, financed by excessively cheap real capital – (not just Bernanke & Greenspan but further back to the end of the gold standard, and in fact even before that as it was this misallocation of capital that forced us off the gold standard in the first place). If capital had been allocated productively, then by definition debt would fall as a percentage of GDP. Total debt may rise, but efficient allocation of capital would always mean the economy would grow faster than the debt as it means you are making a positive rather than negative real return on that capital.
Whichever way you look at it, capital has been massively misallocated for years.
Corporate profits… or massive debt-funded ponzi scheme?
How can that be when corporates report massive profits? The profits are based on paying their workers a salary that meant they could only buy the goods they made by borrowing; in other words, a massive unsustainable ponzi scheme that could only ever end up with default. Without the household debt accumulation, there would be no market to sell their products to, and without paying the workers sufficient, the debt would always have to default.
This required a massive increase in financial innovation to keep the illusion of corporate profitability alive – (household debt was a way of delaying putting the true costs through the corporate P&L account and recognising the costs). Financial sector innovation is itself another form of capital misallocation, taxing people away from real innovation – (to keep the illusion alive, an ever greater percentage of economic output had to be allocated to this illusion machine) – helping add to the resource constraint we are in today.
If financial innovation, which we have so much of is not needed, what is the right kind? And why is it so sorely missing.
A lot of what are described as efficiency gains have been just the removal of levels of safety and the removal of innovation in the system. Innovation and ongoing operations are always and inevitably in conflict, with the most readily apparent conflict between short and long term priorities. A second handicap to innovation is the way efficiency is achieved by breaking down things into small repeatable tasks. This specialisation and repeatability is a company’s greatest strength, but it is also its greatest weakness. Innovation is neither repeatable nor predictable. It is non-routine and uncertain. (Book: The Other Side of Innovation).
The culprit: none other than the great moderation, and, now, ZIRP4EVA:
Low real interest rates support excessive consumption, taking money away from innovation and balance sheets. When the US started suffering from its peak oil in 1970, rather than innovation it turned to globalisation to tax the broader global resource balance sheet, just as Britain and Europe had done 100 years earlier through colonialism, and recently accelerated that with the WTO. Globalisation has always been about accessing resources.
Which bring us to topic #1 here, and everywhere else where economics is involved: cash flows.
This has been a factor mobilisation story on unprecedented proportions, but appears to have reached its conclusion as resource constraint has meant the “cash flow” to grease the wheels has started to become more expensive and constrained. Profit without productivity can only carry on for a finite period; we are now clearly consuming down our balance sheet or putting it through the P&L account.
So we are left with a massive amount of debt, a massive amount of capital and labour that is unprofitable in the world we face, and a balance sheet of insufficient resources to keep the illusion alive. The only thing that will get us out of this in the long run is innovation which will expand the balance sheet, expand the pie and create the jobs that people want.
How do we get rid of the debt? Are we in a debt trap whereby any interest rate hike will kill the recovery? Clearly it is going to be incredibly difficult, but low real rates are the cause of the problem, not the solution. I don’t personally see a zero rate trap, but we need to allocate capital far more productively than we are doing.
The cost of money itself is hugely important. How negative were real rates? When people talk of borrowing from the future, surely the same logic applies to the cost of capital. If we have had low or negative rates that supported excessive consumption, we now need to have high real rates to direct capital back to innovation and gradually repair the balance sheet. The real cost of capital has to go up. No matter how much fighting the Fed and Treasury do, the real cost of capital will rise. The bond markets have to be allowed to clear some of the debt and thereby remove some of this misallocation of capital.
It’s not “debt trap”, it is “Fed trap.”
Does that mean we are trapped in a position whereby the Fed cannot raise rates? Quite frankly it doesn’t really matter what the Fed does; real rates have to go up, are going up and will go up. The more the Fed and the government misallocate capital, the more the real cost of capital will have to rise higher to compensate. The only thing that will get real rates down is either a massive new discovery of incredibly cheap fossil fuels or the innovation that delivers cheap fusion. Otherwise it is a case of the cost of capital rising and causing demand destruction.
Getting the central banks monetary policy inline with the real cost of capital in the market must be the first step to rectifying the misallocation of capital. One obvious thing would be for economists to stop ignoring CPI of food and energy as irrelevant as it is the fastest growing part of the economy. By ignoring it, they are turning what should be a smooth and relatively painless transfer of capital into an occasional out-of control collapse and transfer. Getting both a proper monetary and fiscal policy framework in place, based off genuine data rather than smoke and mirrors and fiddles must be the first priority.
Which brings us to where we are now: a massive, unsustainable ponzi scheme:
Whilst politicians and investors acknowledge that excessive leverage created the asset and debt bubble, they do everything they can to prevent a rational deleveraging or efficient allocation of capital. For the moment the best measure of the cost of capital is gold. For years gold fell as fiat money was printed and this unsustainable ponzi scheme established, however as that ponzi scheme now unravels, gold must go up. The scale of both the ponzi scheme collapse and gold appreciation will be huge.
The problem is total credit market debt is still increasing.
As Fitch recently highlighted, Chinese on & off balance sheet debt has expanded by nearly 40% GDP in each of the last 3 years. In other words, the misallocation of capital is continuing making the ultimate problem that much worse. China is now getting almost no growth per unit of additional debt.
With each additional unit of debt, we are digging ourselves a deeper hole to get ourselves out of. Surely it is better to at least slow the digging? If we can allocate capital productively at the margin – (we know where we need to start making real returns) – then once we can start making a positive return on that marginal debt, then it becomes easier to support the residual debt we have.
If Andy is right, the framework of the next great class class conflict is set: it will be between the productive private economy and the “unproductive economy.” Yes: Marxist tensions are about to make a repeat appearance:
Private sector annuity rates will be tumbling and yet the unproductive public sector are still being given great pensions. We are taxing the productive private economy to give to the unproductive economy. This has to end. The idea of a European fiscal union fills me with dread as that would be locking this unproductive transfer into stone. Rather than keep kicking the can down the road, lets own up to our excesses and start putting the economy back on track. Don’t reward the rioters in London with yet another handout; force them to pay for the damage they have caused and the police time they have consumed.
Is Greenspan to blame for this dead end? Yes… but only so far. One can just as readily blame the traditional duel between short and long-termism, or what is known better as “it will be the other administration’s/generation’s issue.” In other words, Washington is just as guilty as Wall Street, and that infamous private bank.
Why have we misallocated capital for so long? We can blame it on democracy, but bigger than democracy is the culture that forces politicians to favour the immediate status quo over the longer term good of the country. That culture then presumably comes down to poor understanding which comes back to low levels of education. We need to address these route courses.
The real cost of capital has to rise. That will happen through default in one way or another. Debt has to be cleared. Multiple contraction is inevitable.
Financial sector innovation has to be squeezed by engineering and scientific innovation. Until the debt is cleared and capital starts to be properly allocated, economic growth per unit of additional debt will continue to sour.
Energy is the cash flow in this story. Until we get some real breakthrough technology, requiring large amounts of capital to both innovate and then roll out, we have no chance of supporting the economy.
Nothing can be added to this.