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

1 comment:

  1. Could you post your investment selections more frequently? It seems you've been pretty accurate; would sure appreciate your wisdom!