Wednesday, April 28, 2010

banks insolvent? extend and pretend…

first, an excerpt from Extend and Pretend  by John Hussman

With regard to credit conditions, the U.S. financial system continues to pursue a strategy of "extend and pretend." A year ago, the Financial Accounting Standards Board (FASB) suspended rule 157, which had previously required banks to mark their assets to market value when preparing balance sheet reports. The basic argument was that fair values were not appropriate because there was "no market" for troubled assets. Certainly, the FASB could have implemented something at least modestly reasonable, such as 2-year or 3-year averaging, but instead, they changed the rules to allow "substantial discretion" in the valuation of bank assets in their financial reports.

To a large degree, the idea that there was "no market" for troubled assets was false even at the time. Last year, Dean Baker of the well-regarded Center for Economic Policy Research (CEPR) testified before Congress, observing "There has been considerable confusion about the nature of the troubled assets held by the banks. While banks do hold some amount of mortgage-backed securities, these securities are in fact a relatively small portion of their troubled assets. The troubled assets on the banks' books are overwhelmingly mortgages, both first and second or other junior liens, not mortgage-backed securities. The FDIC has acquired large quantities of mortgages from its takeover of several dozen failed banks over the last year. It auctions these assets off on an ongoing basis. The results of these auctions are available on the FDIC website. Non-performing mortgages typically sell in these auctions at prices in the vicinity of 30 cents on the dollar."
He continued, "It is not clear on what basis these auctions can be said not to constitute a market. While the downturn and the constricted credit conditions affect the market, it is simply inaccurate to claim that there is no market for these assets. The major banks are undoubtedly not pleased at the prospect of having to sell off their loans at these prices, but this merely indicates that they are unhappy with the market outcome, just as a homeowner might be unwilling to sell her house at a loss. However, the unhappiness of the seller does not mean that there is no market."

The impact of "extend and pretend" is to create a gap between the reported value of assets and the value they would have on the basis of the cash flows that those assets can reasonably be expected to generate over their maturity. In order to avoid having to restate assets, banks have allowed an increasing gap to develop between the volume of delinquent loans and the volume of loans actually in foreclosure, creating a growing "shadow inventory" of impaired but unmodified and unforeclosed loans.

Moreover, regulatory changes over the past year have affected what actually gets reported as "troubled." As the New York Times recently observed, " A bank owed, say, $4 million on a property now worth $3 million would previously have had to classify the entire loan as troubled. Now it can do that to the $1 million difference only." In effect, even though impaired loans tend to sell at only 30-50 cents on the dollar (reflecting a modest haircut to the amount typically received in foreclosure), banks can choose the amount of assets it reports as troubled simply by choosing what value to assign the property while it holds the bad loan on its books.

While it's interesting that credit card delinquencies have eased off modestly in recent months, this is not necessarily a healthy sign. Even in the third quarter of 2009, TransUnion reported that consumers delinquent on their mortgages but current on their credit cards increased by 6.6%. In effect, people have been choosing to pay their credit cards in priority to their mortgages.

As for policy efforts to reduce delinquencies, I've long argued that it is a bad idea for policy makers to announce delinquency prevention plans that have, as their centerpiece, publicly subsidized reductions in mortgage principal. It's one thing to extend the loan in a way that preserves its present value, by swapping a claim on future appreciation in return for principal reduction, but it's quite another to offer to cut the principal outright. The reason is that instead of confining the assistance to presently troubled borrowers, you create a whole new set of borrowers who then choose to be troubled in order to get the assistance. According to a University of Chicago study, "strategic defaults" - where people choose to default on their mortgages even though they can afford to pay - accounted for 35% of all residential defaults in December 2009, up from 23% in March 2009. Offering public subsidies for this behavior, when too many homeowners are already legitimately struggling, does not smack of a bright idea.

The New York Times recently provided a good picture of how the delinquency situation stood at the end of 2009 (based on FDIC data):









The real concern from my perspective remains the potential for a second wave of delinquencies beginning in data as of the first quarter of 2010 and extending well into 2011. While we've seen some suggestions that many Alt-A and Option-ARM loans have already been modified, the premise of this argument is problematic since it is also true that about three-quarters of modified mortgages go on to default a second time, and few of these modifications result in substantial alterations in principal or interest payments beyond 12 months.

In short, my impression is that investors are deluding themselves about the solvency of the banking system. People learned in the 1930's that when you don't require the reported value of assets to have a clear and tangible link to the value that the assets would have in liquidation, bad things happen. Yet this is what regulatory and accounting rules are allowing for the banking system at present. While I do believe that bank depositors are safe to the extent of FDIC guarantees, my impression is that the banking system is still quietly insolvent.

read extend and pretend in its entirety…



youll note hussman refers to the coming second wave of delinquencies and ultimately, foreclosures…to give you a visual idea of what hussman is talking about here, a couple charts: this first one accompanies an article at calculated risk: New Credit Suisse ARM Recast Chart (click to view full size)

non-business bankruptcy filings

this second chart is from an article at the burning platform: extraordinary recklessness; you can see here that although the subprime mortgage crisis is just about over, the next wave of Alt A & option ARM resets is still to hit full force..


these charts dont even include the souring commercial real estate loans on the banks books, the primary cause for our recent spate of “FDIC fridays”, and which elizabeth warren warns may cause up to 3000 more bank failures…so the question remains, how long can this “extend and pretend” go on?

Note: im adding this late edit since its important and i dont want it to be buried in the comments:     John Hempton at Bronte Capital explains The arithmetic of bank solvency – part 1 

First observation: at zero interest rates almost any bank can recapitalize and become solvent if it has enough time

Imagine a bank which has 100 in assets and 90 in liabilities.  Shareholder equity is 10. The only problem with this bank is that 30 percent of its assets are actually worthless and will never yield a penny.  [This is considerably worse than any major US bank got or for that matter any major Japanese bank in their crisis.]

Now what the bank really has is 70 in assets, 90 in liabilities and a shareholder deficit of 20.  However that is not what is shown in their accounts – they are playing the game of “extend and pretend”.

Now suppose the cost of borrowing is 0 percent and the yield on the assets is 2 percent.  [We will ignore operating costs here though we could reintroduce them and make the spread wider.]

This bank will earn 1.4 in interest (2 percent of 70) and pay 0 in funding cost (0 percent of 90).  It will be cash-flow-positive to the tune of 1.4 per annum and in will slowly recapitalize.  Moreover provided it can maintain even the existing level of funding it will be cash-flow-positive and will have no liquidity event.  (It does however need to be protected from runs by a credible government guarantee.)

Now lets put the same bank in a high interest rate environment.  Assume funding costs are 10 percent and loans yield 12 percent.

In this case the bank earns 8.4 per year in interest (12 percent of 70) and pays 9 per year in funding (10 percent of 90).  The same bank with the same spread is cash flow negative.  


bottom line: expect the Fed to maintain low interest rates “for an extended period” while we continue to extend and pretend..

Monday, April 26, 2010

RealityZone; A New Era ?: China Gains Voting Power At The World Bank

RealityZone; A New Era ?: China Gains Voting Power At The World Bank

Racism is alive and well in Virginia

Excerpt from the article:

Although this is an isolated incident, one comment can shake up a whole demographic of people at the University,” Boswell said, “not just African-Americans, but anyone who identifies with a minority or multiculturalism.”

Check out the link to the University of Virginia paper, The Cavalier Daily

Saturday, April 24, 2010

week ending Apr 24th

the review of the week ending Apr 24th has been completed & posted on the globalglassonion briefly summarizes and links to articles from MSM and the blogosphere, generally on the topics listed below and whatever else, including about 5 dozen links to articles on the goldman sachs fraud charge, and at least three dozen on the ongoing crisis in greece...

anyone who wants my weekly eclectic emailing of miscellaneous & selected links, mostly from these GGO posts, contact me...

Tuesday, April 20, 2010

location, location, location…

articles from two very different north american real estate bubble markets came to me this past week, and i thought it would be worthwhile to compare what you could get in each for your money..

first, ill give you the good news from detroit: home sales were up, inventories were down, & the median sales price last month was up 33% to $7,725! WOW! thats a real bubble!

let’s see what we can get for under $10,000 in detroit…this search of detroit houses on the market there returned 3838 entries at the time of my latest search; of course, this is real time info so you cant count on the same ones appearing as we saw when we first discussed this via email…but tburcher did look further into this house listed for $84,900, with 6 bdrms, 4 baths, & 4370sq ft, which had been on the market 266 days…then he did the address search on Google, then looked at the street view: its in a real nice neighborhood; this was a house that would sell for at least three times as much almost anywhere else in the country…

the other bubble city we’re going to look at is vancouver, canada…so what will $1 million buy in vancouver, BC – a crack shack or a mansion?


click to play: Vancouver, Crack Shack Or Mansion?

tburcher got 13 out of 16, & CheSia & myself got 11 right, so we’ve set the bar pretty high…see if you can beat us…

if you want to check out some more vancouver real estate thats on the market, here’s the the official site of the National Association of REALTORS for the city, which at the time im linking to it is showing 2589 listings; as with the detroit listings site above, this is updated in real time, so any comments you make should take that into consideration…

it should be obvious by now that similar houses in vancouver are quite a bit more expensive than the same size, construction and age of house in detroit – if the listings accurately reflect the market, you should be able to sell a house in vancouver and buy nearly 200 of the same in detroit…so why the difference?  both are transportation hubs, with vancouver being a pacific seaport and detroit having access to great lakes & atlantic shipping…could the climate be that much better? not much, checking vancouver’s climate, it appears summers are cooler, maybe drier, but it rains or snows there on more than half the days during the winter, and gets less than 180 hours of sunlight  november thru january…you can argue one place might be slightly better than the other, and im not even sure which that would be, but at the end of the day its just a place you come home to sleep at, & while youre asleep you have no idea how much you paid for the location your bed is in...

so whats happening in vancouver? the Vancouver Real Estate Anecdote Archive gives us a clue…here’s an example: An early 30s administrator in our downtown Vancouver office asked us if it was a good idea to buy a house with no money down.  She pulls in 35-40K maximum and her husband is underemployed slinging coffee.  We said “Generally no, because of the risk in involved”. I added that rates were going up and she could be easily left with negative equity.  Last Friday, she revealed her latest plan as she scanned the maps on the MLS website.  She and her husband were going to “flip” a property to come up with the downpayment for a house.  After all, she has a cousin who is a carpenter.  She didn’t mention how she was going to come up with the downpayment for the flip.”

Saturday, April 17, 2010

week ending Apr 17th

the review of the week ending Apr 17th has been completed & posted on the globalglassonion briefly summarizes and links to articles from MSM and the blogosphere, generally on the topics listed below and whatever else...

anyone who wants my weekly eclectic emailing of miscellaneous & selected links, mostly from these GGO posts, contact me...

Thursday, April 15, 2010

go figure…

ive been watching this for a year now & no one will explain it to me…

Retail sales surge 1.6% in March – CNN - The Commerce Department said total retail sales jumped 1.6% last month, the largest monthly increase since November, from an upwardly revised 0.5% gain in February.  March retail sales surged 7.6% compared to the same month in 2009.

Texas sales tax revenue down 7.8 percent in March - Forbes… - AUSTIN, Texas -- Texas sales tax collections were down 7.8 percent in March, compared with the same month a year ago. Texas Comptroller Susan Combs said Wednesday that the state collected $1.46 billion in sales tax revenue in March. Although that's down, she said collections continue to moderate for the second month in a row. Following an eight-month stretch of double-digit declines, the pace of revenue losses is slowing, Combs said.

Tuesday, April 13, 2010


the vertical line is a gain of $421.8 billion dollars of outstanding loans and leases in one week's time
it has been suggested that we just bailed out Europe; but even if we didnt yet, since Uncle Sugar provides the lions share of the funding for the IMF, we will eventually…

Monday, April 12, 2010

Magnetar: Inside Job

background: At just the moment that U.S. housing market seemed to be slowing in late 2005, a few savvy financial engineers at a suburban Chicago hedge fund helped revive the Wall Street money machine, spawning billions of dollars of securities ultimately backed by home mortgages. When the crash came, nearly all of these securities became worthless, a loss of an estimated $40 billion paid by investors, the investment banks who helped bring them into the world, and, eventually, American taxpayers. Yet the hedge fund, named Magnetar for the super-magnetic field created by the last moments of a dying star, earned outsized returns in the year the financial crisis began. How Magnetar pulled this off is one of the untold stories of the meltdown.

read the entire article: The Magnetar Trade: How One Hedge Fund Helped Keep the Bubble Going

the following is from: This American Life


Ira talks about a friend who for years had a very trusted business partner and bookkeeper, until one day when he ran away with all of her money. (1 1/2 minutes)

Act One. Eat My Shorts.

A hedge fund named Magnetar comes up with an elaborate plan to make money. It sponsors the creation of complicated and ultimately toxic financial securities... while at the same time betting against the very securities it helped create. Planet Money's Alex Blumberg teams up with two investigative reporters from ProPublica, Jake Bernstein and Jesse Eisinger, to tell the story. Jake and Jesse pored through thousands of pages of documents and interviewed dozens of Wall Street Insiders. We bring you the result: a tale of intrigue and questionable behavior, which parallels quite closely the plot of a Mel Brooks musical. (40 minutes)

We commissioned a Broadway song to go along with this story, which you can listen to here. (Click to stream; right click or control click to download.)

You can also download the sheet music.

And here is a video of the recording session for the song:

Bet Against the American Dream from Alexander Hotz on Vimeo.

Act Two. Taking a Big Pink Eraser to the Thin Blue Line

Michael May tells the story of Barry Cooper, a former crooked narcotics cop who has turned his interest elsewhere... to busting crooked narcotics cops. But after Cooper and a rich benefactor team up to set a trap for the police, Barry's plans are put in jeopardy- including his dream of creating a reality show called "Kop Busters." Michael May is the Culture editor at the Texas Observer. You can watch videos of Barry's police raids at their website. (15 minutes)

Song: "Good Guys and Bad Guys", Camper Van Beethoven

from: This American Life

Saturday, April 10, 2010

week ending Apr 10th

the review of the week ending Apr 10th has been completed & posted on the globalglassonion briefly summarizes and links to articles from MSM and the blogosphere, generally on the topics listed below and whatever else...

anyone who wants my weekly eclectic emailing of miscellaneous & selected links, mostly from these GGO posts, contact me...

Tuesday, April 6, 2010

happy days are here again

alan its-not-my-fault greenspan recently said it ended in the middle of last year; ben bernanke had already declared it over in september, and the National Association for Business Economics said it turned around last october; even all the FRED charts from the St Louis Fed had been modified to show July 2009 as its end, and now robert hall, head of National Bureau of Economic Research’s Business Cycle Dating Committee, the group charged with making the call, has finally has decided that the great recession is officially over…so it appear all the great arbiters of such have spoken: no more bad times, wall street is hiring again, the recovery is underway, back to boom, just go out and spend spend spend like there’s no tomorrow…

however, one of these recoveries is not like the others

[Click to enlarge]

Civilians Unemployed for 27 Weeks and Over

Civilians Unemployed for 27 Weeks and Over


Average (Mean) Duration of Unemployment

Average (Mean) Duration of Unemployment

charts Last Updated:
2010-04-02 7:46 AM CDT

more graphs here…

Saturday, April 3, 2010

week ending Apr 3rd

the review of the week ending Apr 3rd has been completed & posted on the globalglassonion briefly summarizes and links to articles from MSM and the blogosphere, generally on the topics listed below and whatever else, including about 3 dozen links to analysis of  & proposals for finreg, & a similar number regarding unemployment and about the same about the housing crisis...

anyone who wants my weekly eclectic emailing of miscellaneous & selected links, mostly from these GGO posts, contact me....