Archive for the ‘Bailout’ Category
The title says it all: my next blog post will likely be up in August 2009, thanks to a four month sabbatical. Hopefully by the time I return from Southeast Asia / New Zealand / Fiji, the various Fed & Treasury efforts will be having a lasting – positive – effect on the economy. Regardless of if things will look better or worse, I am going to be back with charts and commentary on Wall Street and DC in the summer. In the meantime, feel free to continue to leave comments on my previous posts (they’ve been a huge source of value-add so far, thanks to all who contributed!); I look forward to picking up where we left off later this year.
FAS 157, the accounting rule requiring financial institutions to mark their assets to market, has frequently been cited as a factor exacerbating the crisis. Steve Schwarzman is a vocal opponent of the mark to market rule in its current form, arguing that “the rule is accentuating and amplifying potential losses.” And while I’m sure an accounting rule is not the cause of the mess we’re in, I don’t always see the cause for marking assets to market – especially if they are fixed income products intended to be held to maturity which suffer primarily from a lack of liquidity in the market and only secondarily from fundamental impairment.
Today there’s talk of potential changes to FAS 157; at a minimum, it seems like we can expect to see some guidance on the application of the rule that might qualify or relax the mark to market requirement. I haven’t yet made up my mind if I should like this development – one half of me appreciates the potential relaxation based on the above reasoning (liquidity vs. fundamentals), but the other half fears that a decrease in transparency may cause prolonged or additional trouble down the road.
In addition to the impact FAS 157 has on asset markdowns, though, there’s another important side effect of the rule that tends to be forgotten: financial institutions know that they will have to mark their books to market, using whatever price comparable securities last traded at when they value the securities still on their books; as a consequence, when banks unload parts of their portfolios of toxic assets, they will make sure to sell those securities that are of good enough quality to find buyers at the price that the bank’s’ book was last marked at – otherwise the bank would not only take an additional loss on the assets it is selling, but it would also have to take further writedowns on the securities remaining on its balance sheet. In an environment like today – i.e. one of continuously deteriorating fundamentals – this means that sellers will have a strong incentive to sell higher quality assets first. The result: increasing toxicity of the assets left on the balance sheets of financial institutions. Where’s the silver lining?
Over the last few months we’ve seen a drastic increase in bank reserves. As I’ve pointed out on previous occasions, banks are soaking up the liquidity provided by the Fed’s various programs and the credit crunch continues. But what’s the reason? Is it that banks are unwilling to lend in the current environment, trying to cap their losses? JPMorgan recently argued that it’s not the supply of credit that has collapsed, but the demand for it – consumers are hunkering down and have lost their appetite for spending; businesses that suffer from weak demand don’t require as much credit as they do in prosperous times; and hedge funds have grown weary of leverage. It’s a bit of a chicken and egg problem, but what do you think: is the credit crunch driven by the lack of supply or the lack of demand?
The money multiplier is money stock M2 (money & close substitutes for money) over monetary base M0.
The Fed et al published their guidelines for the Supervisory Capital Assessment Program today, defining the parameters for the base case and adverse scenarios to be used in the bank stress tests. As Paul Krugman points out the stress test scenarios are somewhat of a letdown. The summary table below show the base case and adverse scenario assumptions for GDP growth, unemployment and home price appreciation over the next two years. The original can be found here.
I was under the impression that a stress test should be designed to take a look at possible outcomes under extreme scenarios. To me, the above hardly seems extreme – especially when comparing the HPA and unemployment numbers to what some of the MBS hedge fund managers I talk to on a regular basis tell me they are using as their “conservative” assumptions: -35% for home prices, unemployment in the mid teens. Is the government putting the banks through a useless exercise?
Two days ago President Obama signed the 2009 stimulus package into law, committing an additional $787 billion to supporting the American economy. A number of banks – JPMorgan, Citigroup, Bank of America and Wells Fargo among them – have agreed on temporary moratoriums on foreclosures. Weekly mortgage applications jumped 46% last week, and (as noted in my last post) a variety of indexes seem to be slowing their decline. Credit Suisse recently suggested that the much-bemoaned US debt to GDP ratio might not be in as bad a shape as commonly assumed. Yet the S&P500 lost -4.6% the day President Obama signed the American Recovery and Reinvestment Act, and the Dow Jones gave up -3.8%. As of February 18, the Dow Jones has lost roughly 14% for the year. I have no idea when equities are going to see a bottom or when the economy is going to reach a turning point. I do believe, though, that there are certain prerequisites to be met before a lasting recovery can begin:
1) We need some signs that the stimulus package is working.
In their January meeting, the minutes of which were published yesterday, the Federal Open Market Committee once again reduced their 2009 growth projections. The consumer confidence index stood at 37.7 in January, its all-time low since inception of the index in 1967. I think that consumer and investor confidence will only tick up again as the tax cuts and spending programs of the $787 billion stimulus package (hopefully) prove their effectiveness over time – per the Congressional Budget Office’s estimates the stimulus will add somewhere between 1.1 and 3.8 percentage points to real GDP in 2009, and have an effect of similar magnitude in 2010.
Take a look at the charts below for a breakdown of the stimulus package, and an estimate from JPMorgan showing the sizing of tax breaks and spending quarter by quarter. Please note that the JPMorgan graph dates to the first week of February and is thus not a fully accurate reflection of the stimulus package that was passed on February 13.
2) Systemic threats on both the national and international level need to be resolved.
Temporary calm returned to the US markets in December of 2008 after the government committed to “doing all that it takes” to thaw credit markets, stabilize the financial system and revive the economy. Talk of an impending collapse of the US financial system subsided as it became clear that the government would do everything possible to prevent another Lehman disaster. I believe that we need a similar commitment from the EU regarding the escalating situation in Eastern Europe, and from the US government and banks regarding the prevention of potential systemic shocks such as a large-scale municipal default (think California which just managed to corral the last vote needed to resolve the budget impasse) or a spike in mortgage defaults triggered by a wave of simultaneous interest rate resets.
3) We need to recalibrate our expectations regarding homeownership, leverage and GDP growth.
It seems that by now both Wall Street and Washington and have understood that we can’t go back to “business as usual” – i.e. our pre-crisis reality. For a while to come, banks and hedge funds won’t be as leveraged as they were over the last decade. American automakers need to revamp their business models. I personally don’t believe that almost 70% of households in the US can afford owning a home (stay tuned for a post outlining why). I don’t think that a personal savings rate in the zero to three percent range is sustainable. And I don’t see how increasing reliance on debt – both private and public – can continue to drive GDP growth going forward.
The charts below show the US debt to GDP ratio (the revised version from Credit Suisse) over the last 100 years, the growth of GDP compared to the increase of productivity in the US since 1965, and the development of homeownership over the same period. Looking at these long-term trends, I believe that we’re in for a prolonged period of pain – after all, the stimulus package addresses the symptoms of the crisis and not its causes: leverage is shifted from private to public, instead of being reduced; homeowners who can’t afford their homes are receiving support to avoid foreclosure.
What do you think needs to happen in order for things to get better?
Over the last few days there has been plenty of press about how and why Geithner’s annoucement of the rescue plan on Tuesday spooked the markets. The Dow ended the day down -4.6%, financials were down somewhere around -10%.
That’s the equity side of things. Corporate bonds suffered, too, on Tuesday as money flowed back to the perceived safety of Treasuries – but at least CDS showed no knee-jerk reaction to the Geithner plan: they did widen, but not materially. A silver lining?
CDS on Select Banks (US & Intl) through February 13, 2009
The government is adding to the bailout tab almost daily, and no slowdown is in sight. The total cost of equity infusions for financial institutions, guarantees and lending facilities to date is estimated anywhere between $4 and $8 trillion, depending on which programs are included in the count. The following chart shows some of the biggest ticket items in the US budget over the last 200 years, adjusted for inflation (i.e. in today’s dollars).
Below is the same chart, this time including the 2008 / 2009 bailout package (using the most conservative end of the range with an estimated total cost to date of $4.3 trillion). For reference, the total cost of World War II to the US was roughly $3.6 trillion.
Remind me why people are still talking about “deleveraging”?