Tuesday, March 31, 2009

Bad Program for Bad Assets

The Geithner Plan Will Kill US Banks Profitability

It seems that a lot of people are saying that private investors will overpay for bank assets because of the non-recourse loans. What they forget is that Lone Star purchased Merryl Lynch 'super senior' AAA CDOs last year for $6.7b, the notional amount of the CDO was $30.6B, it was carried on the books of merryl at $11.1b, Lone only paid a little over half of carrying value and they only put $1.675b down and the rest $5b was financed with a non-recourse loan.
Yet Lone Star got a heck of a deal(their risk aversion demanded good terms) as their down side is $1.675b and the upside is in theory $30.6B, the only recourse Merryl has is the asset itself. I understand some folks will say its the FDIC/Fed who will foot the bill instead of the bank like in the MER transaction but from a buyers(bid setters) perspective who foots the bill almost doesnt matter as a long its not them.

The private sector is very risk averse right now and they want bargains or they wont buy it, no cheap put will turn scared investors into gamblers. That Lone Star deal was done before Lehman went bankrupt, the Geithner bad asset plan will kill the banks, if they hit thoses bids they will be left far less profitable and less solvent. Private common equity offerings wont popup all over the place like Geithner hopes, he will have to provide the equity capital or nationalize the banks and wipeout the debt to 'create' capital

Monday, March 30, 2009

World Trade Disorganization

World Trade Is In Freefall with No Bottom In Sight

The CPB of Netherlands is out with a report on world trade that is downright frightening
CPB World Trade Report

World Trade Volume has collapsed at a 40% annual rate in the last 3 months. Now mind you that the total collapse of trade during the 30's was 66% peak to through(source: US Dept of State, I do not know if this data is for volume or is the dollar figure, is likely to be an amount not adjusted for the deflation of the time, that is the dollar volume), the current dollar volume collapse in world trade is at 20%(the collapse is running at roughly 41% annual rate), so in just a few months world trade has collapsed almost a third of what it took 29-34 to build it. We do not have Smoot-Hawley but we do have Citibank, credit is more important to the functioning of world trade these days therefore its having a similar impact, whether goods and services don’t cross borders because of politicians or troubled banks the economic effects will be the same, lower living standards and economic depressions.
That said protectionism is going on without much trouble as the world bank is reporting most of the G-20 countries had no trouble signing more tariffs and barriers after claiming free trade was good, and this is a on going politician reaction that will not stop anytime soon

Back in January I suggested world trade was in for a hard landing because human nature had not changed and the temptations didnt either, so far they way its going it will end up as a total crash with no survivors.
However at some point some kind of stabilization is likely to occur as the 'low hanging fruit' is shutout of trade but the main important products are not likely to be going nowhere(oil-energy products, food products as no politician wants riots, some medicines)so that annual rate will almost certainly slow down and further declines will be harder to generate.

The credit component however is still worrisome. If the US has policymakers who are slightly more knowledgeable than others in dodging depressions and STILL were not able to stabilize their banks and credit what does that say about dozens of other leaders around the world being able to create their soft landings? It says my statement that the "world fate is in the hand of morons" is likely to play out and things are in for a rough time, governments are not likely to prevent it as they don’t seem competent enough

My government skepticism has led me to keep a Short Assets bias through 2009, even though I kept hearing market savvy folks like the ones from Pimco assuring that the government was going to save the day(While at the same time refusing to take risks). Its likely that they wont, these problems are big and difficult to solve and efforts like 0% rates, credit facilities, stimulus plans, etc can HELP but they don’t seem enough, furthermore those efforts need to be applied in a global scale and when you see the protectionism getting out of hand and the slow response/success in stabilizing banks you know what they take out the benefits of some policies they are creating, so it could be a wash in the end

I’m not suggesting a Great Depression is likely, there is simply no deflationary gold standard to lock central banks into watching deflation to take hold. CBs are globally printing money(this intervention they are getting it right as it doesnt take a genius to fire up a printing press), even Trichet has complained his way into almost 0% rates but I do suggest depressions could became more widespread. It wont hit just Iceland and a few other names, it could hit a good chunk of the developed world and this is all very frightening

Thursday, March 26, 2009

Financial Sector Spiders

The coming XLF crash of 2009

I just finished writing a research report I made for a firm. I was able to make it avaliable for free(The report is free for distribution of any kind for the next 30 days)

Geithner and US Bank Stocks

Update: One thing I forgot to add to the report, total assets of the largest banks(more than $10b in assets) is $10,800b their 'surplus' over danger TCE is $226b. This is 50-1 leverage, a 2% change in assets trigger a widespread fear that the world's largest banks are becoming insolvent. Not a healthy system

Update 2: Total losses taken number is incorrect. Its actually near $800b according to Ft.com data, however my numbers of losses 'left to go' already uses the right data so no harm there. The 'rough estimate' on big banks TCEs is rough but VERY likely to be correct.

Tuesday, March 24, 2009

Timothy Geitnher

Geithner Bad Asset Program will DECREASE Long-Term US Banking Capital

Bill Gross from Pimco is saying he expects to make 'double digit' gains from the bad asset program. Pimco, Blackrock and others will the first in line for losses from this program along with the treasury. If they are 'gaining' somebody else must be losing and it cant be the FDIC/Fed because the private investors/treasury will be the first in line for losses. This leaves only one group left to lose: The Banks

Bernanke back in Sep/Oct was mentioning the hold-to-maturity value and the market value of the assets. He was essentially saying the run-off value of a bad asset was X and the market bid was X - Y, the disconnection happened because no one could leverup to buy these assets and there was some uncertainty to extreme losses in those assets.
Then Geithner came up with this plan in order to 'connect' these two values again. In my view, the connection will not totally occur.

Think about it, the hold-to-maturity value of a bank asset is something you cant know before the fact, as a result private investors will try to GUESS what this value is, due the risk aversion currently present, plus investment grade corporate bonds yielding 7.5% and junk bonds yielding 17% is likely investors will demand a DISCOUNT to their GUESS of what the hold-to-maturity value is, that is they will demand a risk premium, they will demand compensation for political risk(like not being able to walk way from a large non-recourse loan), liquidity risk, credit risk, congress risk(I understand there is a cheap put and cheap funding but in the risk averse market right now that is not enough to offset the risks). Now, if they get this risk premium and make 'double digit' returns then the banks necessarily need to lose. So if this plan succeeds, the banks by definition must have lost money/future earnings. There is no such thing as a free lunch

To put it more simply, if the banks were allowed to run off their books without suffering a run they would return X from their bad assets, by selling to the bad asset program they will get X - Y, Y being the money that will endup in Blackrock bonus packages

This means for every bad loan(which is not marked to market) a bank sells to the bad assets program the Net Present Value(the long-run value of an institution) will go down, all else being equal, they also will have to raise shares, hurting the stock. When it comes securities(which are marked to market) its a bit more tricky because it might be a good idea to take the loss since holding the security could force you to mark the asset to irrational ABX numbers. But still it will decrease the value of that bank long-run asset side value putting the bank is a bigger hole

Another simple example is, suppose you had a corporate bond fund in Jan 2008 with a bunch of junk bonds in it. Its March 2009 and you have liquidity issues. You are forced to sell securities at a market clearing price, its quite likely buyers of of a diversified set of junk bonds will likely make money right now even if a few of them default, that is because the yield on junk bonds are very high compared to the likely default rate(that would have to reach Great Depression scenarios to make the buyers lose money), so the 'earnings' that buyers got come out of your pocket, the long-term value of your bond fund went down.
This happens because the market right now is depressing the value of all types of assets, that is risk premiums(the compensation the buyer gets) are very high, this means being a seller of assets is a bad deal these days. This is a buyers market where you dont want to be a seller at the market clearing levels

So ignore the critics that say this is a hidden way to give capital to banks, its not. It does just the opposite, its puts banks in bigger balance sheet holes

Therefore the Geithner plan is a hope private common stock capital will save the day once the banks are a bit cleaner in their balance sheets, it does this at the cost of making banks sell assets below their run-off values and decreasing their long-term capital(they get more insolvent). The hope is that if private common stock capital comes in, recaps the banks making them very solvent then banks will lend again and as an GROUP the US Banking system will increase its Net Present Value as the economy will grow again. Its a bold plan(particulary given that Congress does not want to give more funds for banks) but at this point I'm not quite sure if it will work

Wednesday, March 18, 2009

Ask the MA

When to go Long Stocks/Commodities/Bonds?

This is a question investors ask themselves everyday and they seem to be inundated by an avalanche of opinions and 'news' items as a result they act like manic depressive patients with chronic zinc deficiency. I'm going to present a very simply method that can save you HUGE amounts of money when there is a nasty bear market(like this one) and guaranteed you that you will NEVER miss a bull market in any financial asset. Its called the 200 day moving average, you sell everytime a long-term chart of the asset falls bellow that and buy everytime it goes above it

And this is not some technical analysis mumjo jumbo, its empirically tested. I highly recommend the following research report(they use the 300 day on the paper but results should be similar)

The paper shows that the 300 moving average system reaches the same kind of returns buy and hold does with less volatility. Furthermore it works in non-US stock markets and other asset classes as well.

This simple method can easly save investors huge amounts yet people rather pay attention to an neverending stream of news and opinions.

Right now I'm mostly short a number of stocks(JPM,GS,CAL,C, others) own puts in others(have a large put position in a company which I can't name), cautiously long a few names and I considering increasing my corporate bond exposure, I will however not take any meaninful risk while doing that, why? LQD/JNK(corporate/junk bond ETFs) are both bellow their 200/300 day MA. So I'm sticking to the safest credits I can find(Citigroup bonds, too big to fail and I'm hedged through the stock short, International Lease Finance Corp, profitable company that can be bailed by AIG if it runs into trouble, plus it got $43b in airplane assets against $30b in debt so its quite solvent in a bankruptcy) and I will remain in a defensive stance till they break their MAs.

I will surely miss the bottom(so what everybody does) but I will also dodge a complete collapse in financial markets/global economy in a protectionist hell which IS possible at this point

Monday, March 9, 2009

John Hussman

John Hussman's flawled argument
John Hussman is out with a flawed article on why the government ought to give haircuts to bank bondholders
Its amazing that someone from his caliber would write such absurd set of arguments and then try to claim "Oh Btw, there is no way I'm wrong"

He writes:
"The course of defending the bondholders of insolvent institutions is not sustainable. Do the math. The collateral behind private market debt is being marked down by easily 20-30%. That debt represents about 3.5 times GDP. That implies collateral losses on the order of 70-100% of GDP, which itself is $14 trillion. Unless Congress is actually willing to commit that amount of public funds to defend the bondholders of mismanaged financials so they can avoid any loss, this crisis simply cannot be addressed through bailouts. Bondholders have to take losses. Debt has to be restructured. There is no other option – but the markets are going to suffer interminably until our leaders figure that out."

Its absurd to look at collateral losses then claim that somehow creates a hole in the banking system that congress would have to fill. Why?Because it assumes every mortgage defaults(that assumption doesnt go into his 10y stock market return forecast interestingly enough). One of the most bearish projections in total losses is from the Roubini Team at RGE, they project $1.8 trillion in losses for US banks and broker dealers, which the government can easly handle since demand for treasuries is still high, and IMF/Goldman figures are lower than this. It makes no sense to induce stress in this already weakned financial system by adding more losses to the system through the banking corporate bond channel.(Which would set a cascade of counterparty fears all over again)and remove all the going concern value that exists in some banks

Plus there is one more bottleneck which Bernanke has stressed, the US government does not have the legal authority to take over banks and 'haircut' bondholders(or even common or preferred holders for that matter). Citigroup has about 11% in Tier 1 capital, they have had 'adequate' capital for a while now and their regulators have approved that(other wise Citi would be in the troubled list or they would have been pressured to write some assets down and their Tier 1 would have tanked). Without a bank dropping below adequate capital levels or running into liquidity problems(Like Indymac like so many use as an example) they just cant seize private property like that, the FDIC friday banks we see being taken over every week usually have high texas ratios, illiquidity, etc
The bank itself can refuse a take over and they setup a massive lawsuit. The regulators cant stamp an approval on the Tier 1 ratio in one hand and nationalize in the other.
So while its fun(and probably correct) to call for nationalization its impratical in the real world
This means the current bailout policy of quasi nationalization(with regulators 'working' with bankers) and more injections look like the mostly likely path going forward. Geithner will own XLF by the time he is done