OH, WHAT A MESS WE WEAVE ...

Money Morning is one of a handful (or two handfuls?) of investment newsletters that I get on a regular basis. While the ultimate goal of these e-mail newsletters is to sell you their investment products there are several that provide very good market news and political analysis. Money Morning is one of those newsletters.

In this Money Morning review - "Obama Stimulus May End Up Hurting the Economy it Was Supposed to Have Helped" - Martin Hutchinson writes that because President Obama's economic stimulus package adds to our national debt that interest rates are starting to climb. This is not news; it's Economics 101 stuff.

The news lies in the impact that rising interest rates will have on a housing market that is being beaten down by foreclosures and the effect of rising unemployment.

Hutchinson predict that if housing prices continue to fall (which they will; see my "These Guys Still Don't Get It" post below) then "on average every 80% [of] mortgage[s] undertaken since May 2002 ... would be underwater." Let me put this another way - and as a way of emphasizing - the net effect of a continued collapse of housing prices would be that every home owner who purchased a house with 20% down since May 2002 would owe more than it's worth. Why is this scary? Because people will walk away from their homes in droves.

How do you fix this? There are several ways. One, which I've been suggesting over the past year, is to nationalize the failing financial institutions. This would allow the federal government to renegotiate home loans that are under water rather than leaving the job in the hands of a failed industry that is not negotiating in good faith.

Think about it. The U.S. taxpayer is going to get stuck with the bill either way. But I'd rather get stuck with a scenario that stabilizes home ownership (good for Main Street) rather than with a scenario that includes record foreclosures, a wrecked housing market, and subsidies for financial institutions and market players who got us into this mess (which Wall Street wants).

Unfortunately, President Obama listened to Wall Street and ignored Main Street when he left the failing banks in the hands of the morons who got us into this mess. Today they will not negotiate in good faith with homeowners who have stable jobs and who want to stay in their homes because they - and the market players who own a piece of the mortgages - don't want to see the value of their "investment" go down. I'm not sure what this is called, but in my book, this is not capitalism (seriously, read my book, it's not capitalism).

At the end of the day, if the housing market continues to collapse, we need to let Wall Street know that they will also have to pay a price for their greed and stupidity. We can't just let homeowners and the American taxpayer pay for this mess in the form of bankruptcy, foreclosures, wrecked credit and future tax burdens.

- Mark

STRESS TESTS & NATIONALIZATION

Want to read some mind-numbingly laid-back specs for the banking industry? Take a look at the methodology outlined by the Federal Reserve for the infamous "stress tests" that banks are supposed to follow.


Ultimately, the goal is for troubled banks to provide information that will give us an idea as to whether they could survive several "stressful" economic scenarios. The pathetically low standards for the Stress Tests - also known as The Supervisory Capital Assessment Program: Design and Implementation - are only matched by the program's willful ignorance of the banking system's insolvency. Jule Satow outlines some of the problems here:

1. Banks Get to Determine Risk-Weighted Asset Values: Are you kidding me? We have to accept what the banks - who have been so good at honoring their fiduciary responsibilities in the past - say their toxic assets are worth? They're already loathe to renegotiate troubled home mortgage contracts because they don't want to reduce the value of their loan portfolios, so to expect the banks to be honest with us about their total assets because "it's the right thing to do" is asking for trouble.

2. Debt-to-Capital Ratio of 25 to 1 are Allowed: This is far higher than the 12 to 1 ratio that the SEC required of banks before the fateful 2004 decision that allowed the five largest investment banks to increase debt loads (discussed in Chapter 12 of my book, p. 275).

3. An 8.5% Loss Rate for Commercial Real Estate Portfolios: This not only depends on consumer spending picking up (have you seen consumer debt loads?) but is a very generous standard since default rates on commercial real estate have quintupled since the beginning of 2008.

Making matters worse is that little to nothing is said about the $50 trillion (about 3 x's our nation's GDP) in derivative trash that's still on the books ... or that several of the largest bank's exposure to derivatives exceed their total assets ... or that the FDIC is essentially running on fumes with approximately $50 billion left to cover 8,000 banks with about $7 trillion in deposits ... or that many of our financial institutions are pretty much insolvent zombie banks without the Fed's life support.


With these embarrassingly weak standards, and developing realities, I'm surprised that the Stress Tests don't require bankers to take a vacation in Tahiti. You know, to take the edge off of their stressful days from making stuff up.

Seriously, as Anthony Citrano suggests, the stress tests are akin to you going to your medical doctor for a physical that you need to pass for your job (after you've spent a year partying and eating as if you were in a Roman orgy) then having your doctor ask you if you want a clean bill of health.

Look, unlike Rush Limbaugh and the Republicans in Washington, I want President Obama to succeed. We need to nationalize failing institutions and the zombie banks, which will allow us to force failure on the clowns and the toxic instruments they helped create.

Unless the banks are weaned from government life support, these Stress Tests do little more than tell us what the banks want us know.

- Mark

THE SHADOW INVENTORY OF HOMES ...

It looks like a "shadow inventory" of foreclosed homes is building up, which could "wreak havoc with the already battered real estate sector, industry observers say."



Many banks are sitting on foreclosed homes rather than selling or even listing them. Here's what the SF Chronicle says about the situation:

Lenders nationwide are sitting on hundreds of thousands of foreclosed homes that they have not resold or listed for sale, according to numerous data sources. And foreclosures, which banks unload at fire-sale prices, are a major factor driving home values down.

Why is this important? Because there's a mountain of adjustable rate mortgages ready to blow through our collapsed (still collapsing?) real estate market over the next few months.
In a few words, the president's $75 billion home loan rennegotiation program is/was absolutely necessary. The problem we have is with the banks. Which brings us back to what I've been advocating for some time, nationalization

- Mark

MY EXCHANGE WITH A WALL ST. ECONOMIST

Last week I received a copy of what I'll describe as a “Market Outlook” review, produced by what was once one of the biggest financial institutions on Wall Street. In a few words the piece complained that things would go from bad to worse under President Obama because his programs were bringing “Big Government” back. It got me going because it came from one of the firms that had been saved by tens of billions in taxpayer dollars.

I looked up the e-mail addresses of the Wall Street economists and – more to blow off some steam than to initiate a dialogue – I sent the following message to the authors. The title of the post was “You Need Help” (I've corrected typos and changed names):

Dr. Wall Street Economist:

I just received your "The Return of Mr. Big Government" analysis.

It pretty much sums up why Wall Street still doesn't get it. No where do you try to explain that "Big Government is Back" because "Big Business" fell flat on it's face and decided to take the country's economy with them. At the end of the day everyone at your firm should be unemployed or looking for work. You don't seem to understand that many in your industry owe your current employment to Big Government and the American taxpayer.

That you try to frame current events in the same manner as a FOX News team says much.

And your prognosis on what happens when you "raise taxes on those earning over $250,000" lacks depth, or any reference to what happened in the 1990s.

Get help (and not from the American taxpayer), please.

Not expecting a response, I logged off. I was surprised to see this in my in box when I came back to my computer (I’ve cleaned up the typos).

Mark:

Thank you for taking the time to send this email, even if you disagree with the message. These indeed are very troubling times and the government is doing all it can to underpin domestic demand and ensure social stability. My own belief is that Washington should be focused on assisting the state and local government sector, which is the second largest part of the economy and cutting back on services and much needed capital spending ...

Huh?

I couldn’t believe it. These are the same guys who collapsed the economy by borrowing money they didn’t have, to bet on products they didn’t understand. And they think sending money to the states so they can cut services and invest in infrastructure (the logic here is rough) is the first step toward fixing the economy?

But wait, it gets better …

… I think given the size of the borrowing requirement from the government, we could very well run into a wall very soon. Even FDR kept the deficit contained at 6 pct of GDP......spending money wisely is essential and we have too much of a fiscal boondoggle at the federal level.

Nice. State the obvious ... and leave out the role of the previous administration in running up record deficits every year. Hey, I have an idea: How about NOT collapsing the economy by betting on financial gimmicks and then having them insured with market players who don’t have the money to pay off on claims?

In the next section Mr. Economist falls back on economic theories that have little to do with the issues at hand, and then sprinkles his point with a little false bravado. Check this out ...

And I agree with you about financial bailouts, and I feel the same about auto bailouts, and this country was built on creative destruction. Most of the people that lost jobs at RCA, Pan Am and Penn Square got jobs elsewhere or retooled and I'm frankly quite willing to do likewise . . .

Look, “creative destruction” refers to outdated industries being replaced by new technologies, or a workforce being forced into new lines of work because of competition. The horse & buggy industry was greatly diminished by the arrival of the train and the automobile industries, for example. Those who worked in the 8-Track tape industry lost out to those working with cassettes, which lost out to CDs, and so on …

The problem here is that, as much as they want to believe otherwise, the new kings of Wall Street aren’t like the Robber Barons of the past. Nor are they replacing old technologies and habits with new more efficient industries. Put simply, they built financial sand castles and sold them like snake oil. At least the Robber Barons who contributed to “creative destruction” in the past left a trail of brick & mortar and some pretty solid blue collar industries in their wake. Today's market fools simply collapsed the economy by making stupid bets.

Interestingly, the stupidity continues . . .

Bailing out banks was not something Mr. Abbot or Mr. Costello requested [he was speaking in the third person here] ... It is being mandated by Obama, Geithner and Bernanke. Yes, yes, the Wild West was created in the financial sector, and yet the regulators (Greenspan) were asleep at the witch.

Incredible. Mr. Abbot is simultaneously saying his company had nothing to do with their collapse while claiming they were forced into being saved with billions of taxpayer dollars by President Obama. There were no other options (like, say, a government takeover). Mr. Abbot wants us to believe that his company was simply caught up in some Big Government conspiracy that was concocted after Big Government fell “asleep at the switch” – irresponsibly leaving the banks to regulate themselves - only to wake up in time to impose uninvited order. Huh? (if you're having trouble following Mr. Abbot's line of thinking, you're not alone).

It’s this kind of pretzel logic that tells me we need to nationalize the failing institutions and force a little creative destruction (i.e. "You're fired.") on Wall Street’s economists - especially the ones who think like this.

Seriously, these people don’t need jobs. They need help.

- Mark

GEITHNER'S "ROCKY" ROAD

It's bad enough that Treasury Secretary Tim Geithner's performances in front of the media and Congress have been reviewed like a Sylvester Stallone movie without Rocky or Rambo in the title. Now Geithner's got the former Prime Minister of Australia, Paul Keating, ripping into his performance during Asia's economic meltdown in the 1990s - the performance that was presented to all of us as Geithner's "Rocky" moment.

How big are these developments? Think about it. Would you have gone to a Sylvester Stallone movie if Rocky and Rambo were somehow erased from your memory (yeah, I didn't go either, even with Rocky, but play along here).

The American Prospect's Robert Kuttner is even suggesting that we may have been sold a bill of goods. Helping to erase Geithner's "Rocky moment" is the fact that people like Kuttner are starting to look at Geithner's mentors, who (with the exception of Paul Volcker) are now in the financial dog house, and the fact that Geithner was head of the Federal Reserve's New York district office when the market meltdown began. In a few words, Geithner is slowly projecting like a bad Sylvester Stallone movie.

This is important because President Obama came into office with a distinct mission: calm the markets and set the stage for stability and growth down the road. Geithner's performances and his mentors are not helping him now. And it's getting worse.

Nakedcapitalism.com is pointing out that the bailout of AIG may simply be a way of funneling money into other market players, here and abroad. If we want to put this in a negative light, AIG is simply a front company - used as a clearing house for shoveling money into financial institutions who bought the toxic garbage (subprimes, ARMs, etc.) produced by Wall Street. Here's a list of companies, compiled by the Wall Street Journal, who have been paid off through AIG:

Goldman Sachs
Deutsche Bank
Merrill Lynch
Société Générale
Calyon
Barclays
Rabobank
Danske
HSBC
Royal Bank of Scotland
Banco Santander
Morgan Stanley
Wachovia
Bank of America
Lloyds Banking Group

The fact that this is a "Who's Who" list of global financial players is not as important as this: the bailout of America's financial institutions is slowly being exposed for being little more than a transfer of taxpayer money to the "Big and the Stupid" (sounds like a Stallone movie already) who made bad bets on bad products with money they didn't have. And Geithner was there, watching it happen.

It now appears that we're shoveling money into these global financial firms because, if we don't, the world will blame us for the financial disaster we're confronting because of how we exposed them to our toxic garbage. This is important because it suggests that the world is telling us that if we don't help rectify the situation with their banks they just might quit playing ball with us financially. This, in turn, would force some real ugliness on the American dollar, and cause political panic as the dollar collapses around the world.

In a few words, we're doing this both to save our own skin, and because we want to maintain global political stability (trade partners that become trade competitors is usually a prelude to economic nationalism).

During the Cold War we paid for the defense of the West, and were able to convince the rest of the world to hold dollars. So from a political perspective what we're doing makes sense - even if we don't like bailing out stupidity and greed on Wall Street. There's only one problem here: We're no longer helping the world stave off the Soviet Union and communism (and, No, al Qaeda is not the greatest threat we have ever faced). The cooperation of our allies is now purely commercial and selfish. They want to keep our markets stable. If we blow it there's no telling what could follow.

So, where does this leave us? Here's what I see. President Obama is going to have to make a decision on Secretary Geithner within the next 3 months. If Geithner continues to come across as Sylvester Stallone Obama's going to have to reach for a political Robert De Niro for Treasury (is Paul Volcker open to stepping in?). Here's why. We're eventually going to have to nationalize the failing banks.

A Treasury Department that does little more than prop up the banks with trillions of dollars (there's at least $45 trillion in CDS counter party contracts) that doesn't reach U.S. consumers is simply not sustainable. Few will have much confidence in a partial nationalization game plan (or any Obama plan) if Geithner continues to falter.

What we're facing is too important to continue messing around with weak personalities and a steady drip of shell game AIG bailout stories. We need a Shakespearean performance from the Treasury Department on this one. At this point I'd even settle for the smoke & mirrors of a Rocky movie if it meant buying time for Geithner to grow into his position.

We simply need a better performance from Geithner.

- Mark

NO END IN SIGHT?

This is getting ridiculous.

Insurance giant AIG continues to flounder and just posted the largest quarterly loss in U.S. history: $61.7 billion. Not surprisingly, they're now coming to the U.S. taxpayer for another bailout.

After already having provided a $60 billion loan, $40 billion in the form of purchases for preferred shares, and $50 billion to soak up some of the company’s toxic assets AIG's CEO, Edward Libby, is asking for another $30 billion. Liddy - who came in after the company went south in September, and earns just $1 per year - is saying that the company and the financial conditions are "in much worse condition than I thought.”

Look, if we're going to give these guys more cash - and we will - how about a stipulation that says no more "hideout" junkets for executives, like this one in Phoenix. Better yet, if we're going to guarantee their survival, their profits, their payroll, and their losses, why don't we just take the entire thing over?

- Mark

MORE BANK FAILURES COMING

This is not good. In 2008 we saw ...

* The earnings of the commercial banks and savings institutions insured by the FDIC decline 83.9%.

* 25 FDIC insured institutions fail.

* The number of banks on FDIC's watch list -- the ones regulators are most concerned about failing -- jump from 65 in 2007, to 171 in 2008, and to 252 today.

So, get ready for it: More bank failures are around the corner, no matter what we do.

Again, we are faced with the following dilemma: Do we let the banks go under and have Uncle Sam pick up the pieces, and get nothing in return? Or do we nationalize, secure assets, gain some control, and make some money when we sell the banks back to the market? Those of you who read this blog regularly know my opinion on this ... we need to nationalize the failing institutions.

There is, however, one piece of good news coming out of the FDIC: Total deposits rose 3.5 percent to $307.9 billion -- the largest percentage increase in 10 years. The reasons for this are many, but are primarily tied to people drawing money out of the stock market, only to put it in banks. As FDIC Chair Sheila Bair put it: "Clearly, people see an FDIC-insured account as a safe haven for their money in difficult times."

Or we can put it another way, "Clearly, when the going gets tough people don't trust the private sector with their money."

- Mark

UPDATE: I just ran across this from Naked Capitalism, which they got from the Financial Times. Of the $450 billion in "securities" (CDOs) written from 2005 through 2007 - which banks bought as investments - around 70% of these securities are formally in default (which means no one is paying). Because banks once thought these securities were worth $450 billion - because "really smart people" with computer models told them they were - banks are now facing big losses, which helps explain why they're in trouble. They are essentially holding ghost assets. These ghost assets, my friends, are why the American homeowner, and taxpayers, will get screwed. Mark-to-market provisions in TARP will make sure of this. It's late, and the details aren't fun, so I'll call it a night, for now. But stay tuned.

NATIONALIZE THE ZOMBIES? YES, SAYS KRUGMAN

Yet another excellent op-ed piece from Paul Krugman. This one explains why we need to nationalize failing financial institutions, which are now being called Zombie Banks. In a few words he's saying what I've been saying all along: We already own their losses so we might as well make it official.


The other upside to nationalization is that we put the fear of God into shareholders across our economy. With nationalization we're sending the message: Do your jobs and watch what the people with your investments are doing or suffer the consequences; no more socializing the losses, while you privatize profits ... you, know, the way capitalist markets are SUPPOSED to perform.

- Mark

NATIONALIZE THE BANKS

Economist Nouriel Roubini has been getting republicans to buy into the idea of bank nationalization. Here's his argument in the Wall Street Journal.

- Mark

EXPLAINING OBAMA'S PLAN

If you’re wondering why President Obama has had to introduce a $75 billion plan to encourage loan holders to renegotiate with distressed homeowners here’s a primer.

We know that financial institutions got themselves into trouble by making incredibly stupid loans. If you had a pulse and could fog a mirror you got a home loan. Financial institutions have suddenly got religion, and are now reluctant to make new loans and are opposed to readjusting existing home loans. They contend that they don’t have any money. What they don’t have is a moral compass, or a collective conscience. The reality is financial institutions aren’t renegotiating home loans because it’s not in their financial interest to do so. Here’s why.

• Home loans were bundled together and sold to financial institutions.

• Bundled loans sold as a package – with a total value of, say, $100 million – created new income streams (from the loan payments you and I make).

• Financial insitutions know that if they renegotiate loans the value of each group of bundled loans could drop between 20-40% (or more).

• Financial institutions would rather keep a set of loans valued at $100 million rather than $60-80 million – even if it means burning down the house.

So, this is what we have ...

Financial institutions, who currently have their hand out, and are living off of the American taxpayer, don’t want the value of their bundled loan packages to go down. They want their $100 million, as it were. They are betting that homeowners and other debtors will be held to their contracts and/or that the American taxpayer will end up making up the difference through a bailout program (made possible by Section 132 of TARP).

Unless we nationalize financial institutions and force renegotiations, or offer incentives through legislation, they will not renegotiate with homeowners who are distressed.

This explains why President Obama has had to introduce a new program to induce financial institutions to renegotiate with home owners who are underwater, or have seen their income situation deteriorate. Unless they are nationalized, forced by legislation, or induced with financial incentives the financial institutions will not renegotiate (as FDIC chair, Sheila Bair, found out). If this situation continues we will move from a situation where 10 million homes are underwater today to having more than 15 million underwater within one year. People will continue to walk away from homes, and housing prices will collapse even further. It’s that simple.

This is really the first step of a broader program that is needed. Some may call it incrementalism. I call it a step forward – as long as President Obama does something about reducing expectations on the bundled loan payouts (called Collateralized Debt Obligations).

If President Obama’s program doesn’t do the trick, I say we nationalize the failed institutions and force home loan settlements. The financial industry is derisively calling this option a "cramdown." I like it already.

- Mark

IT'S TIME TO NATIONALIZE

I've said it before and I'll say it again: Let's nationalize the failing banks. It's better than socializing their losses with less than transparent programs, which ultimately bails out incredibly stupid decision making on the part of the banks. Here's what the NY Times had to say about where we stand after having some economists and finance experts look at the numbers:

A sober assessment of the growing mountain of losses from bad bets, measured in today’s marketplace, would overwhelm the value of the banks’ assets, they say. The banks, in their view, are insolvent.

It doesn't get much clearer than this. Even after taking on more than $8.8 trillion of new debt because of the mess the banks created they are, according to the article, still like "dead men walking." The only thing keeping them afloat are FDIC guarantees and the American taxpayer. If taxpayers are going to take it on the chin financially (and we will) I want ownership.

And, please, no whining about creeping socialism. When it comes to guaranteeing payouts and profits, we're already there. We just have no control. It's time to grow up and face the facts.

- Mark

SOCIALIZING THE LOSSES vs. PARTIAL NATIONALIZATION . . .

The NY Times has an excellent, and brief, six-step synopsis of what went wrong in our economy. In essence it points to a lax regulatory environment (with derivatives, corporate leverage levels, and subprime lending), failed policy responses (to foreclosures and Wall Street bailouts), and the colossal mismanagement of the TARP bailout money. Much of the article is old hat now, but for those of you having trouble keeping score at home, it's a quick score sheet that's not too technical (Full Disclosure: I also like it because it mirrors what I say in the last three chapters of my book).

In another NY Times article it's made clear that we're not going to get out of this mess until we clean up the "insurance" gambles (credit default swaps) that were bought and sold between financial institutions.

In this market we had market players buying and selling insurance for products, like debt contracts, that they couldn't pay off if the product they were insuring went south. What these guys did would be akin to you selling outrageously cheap car insurance, knowing full well that you wouldn't be able to pay out if people started wrecking their cars. Worse, apart from never planning to pay out on claims, the only thing you were really after was the monthly premiums. Bailing out this group of market players not only rewards bad behavior but will cost trillions of dollars.

Or we could do the smart thing and force losses on those who were gambling on America's economy going south, and didn't really care what they bought as long as they had "insurance." Think about it. If you purchased a bad insurance policy for your car the government wouldn't say, "that's alright, we'll pick up the tab for your wrecked car." We need to force losses on those who perpetuated an irresponsible system, gambling that the government would eventually cover their bets (by enforcing contracts, or by bailing out the industry). Read the article because it has several good recommendations.

What does this all mean? It means we're in a real mess. We've already encumbered at least $2.9 trillion in new debt but have little to show for it. Socializing the losses by having the American taxpayer pick up the pieces for stupid behavior is not good policy.

This is one of the reasons why I believe that partial nationalization of America's failing financial institutions is the best option available. Why? Because we get some control over bank actions (which we have to bailout anyways), and it will put the fear of God into an industry that has yet to learn any lessons from this mess (as they continue to pay out billions in bonuses, refuse to discuss what they're doing with TARP money, etc.).

The NY Times discusses the nationalization issue here.

- Mark

THIS IS WHAT WE SHOULD DO . . .

Billionaire financier, and all-around smart guy, George Soros has an excellent article discussing the choices that face us on the economic front in Thursday's Financial Times. In the article he writes that we have two choices:

1. SOCIALIZE THE LOSSES: Leave the banks in private hands, and buy up their toxic debt (at least $1 Trillion). These toxic instruments would then be put into a monster "aggregator bank." This is what the USSR (United States of Socialist Republicans) wants.

2. PARTIAL NATIONALIZATION: Partially nationalize the banks by purchasing a controlling interest in their stock at current prices, and then inject them with taxpayer money (which would require more than $1 Trillion). Democrats fear this route because they don't to be labeled socialists.

The first option represents a play on what Hank Paulson and the Bush administration did - simply bailout and hand over money to private market players who made incredibly stupid decisions. The only real pain is suffered by the American tax payer. The stupid and greedy win.

The second option offers a clean break with the Bush administration, but would entail imposing significant lossses on shareholders.

I like the second option for two reasons.

First, partial nationalization would allow banks to begin renegotiating with home owners who are either up-side down on their mortgages, or facing a rate adjustment over the next three years. The government will cover the banks losses. We're going to have to cover these losses any ways, so we might as well as do it the right way and get some money into the pockets of Main Street.

The second reason I like partial nationalization is that it would send a signal to shareholders around the world that they need to keep an eye on company executives and watch their investments. They can't continue to privatize the profits and socialize the losses. Simply put, the shareholders and stupid investors who allowed this mess to develop because they didn't want to stop the constantly "inflating profits" gravy train don't deserve a taxpayer bailout.

So, if the choice is between "socializing the losses" (Choice #1) and partial nationalization (Choice #2) I say we do it right and teach "stupid is as stupid does" a lesson.

I'll have more to say on this on today's program.

- Mark

NATIONALIZE THE BANKS?

So far banks have either hoarded bailout money, spent it on shareholders, paid out billions in bonuses, or simply refused to lend to others - preferring to keep the money for their rainy day. Now we have banks foreclosing on builders with perfect records. I heard about this practice from an acquaintence, who had a couple million dollar loan called in despite making all of his payments. And he was liquid!

Anyways, it may be time for us to start thinking about what the Swedes did. They nationalized sinking banks, and made money doing it. Read the story. At the very least, it provides a negotiating tactic.

- Mark