September 23, 2010

The FDIC Nightmare

Posted in Banking, Big Banks, Bonds, Capital, crises, Finance, investment advisor, investments, San Francisco, Uncategorized tagged , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , at 7:46 PM by Robert Barone

Wal-Mart is often criticized because when they put up their store in a small community, they drive out small businesses and mom and pop stores which cannot compete on price.  Nevertheless, Wal-Mart still pays taxes and has a cost of capital, so they cannot go everywhere.  Imagine if a Wal-Mart like competitor to small business existed that had virtually unlimited resources, paid no taxes, and had a 0% cost of capital.  No small business could survive if such an entity targeted a particular business or set of businesses.  Enter, the FDIC!

For over a year I have written blogs criticizing the FDIC’s approach to America’s Community Banks and what I have termed the “Unholy Washington-Wall Street Alliance” (see, for example, Health Care Bureaucracy May Be Like FDIC, March 30, 2010, www.ancorawest.wordpress.com/2010/03/ and Where is the Outrage II, August 11, 2009, www.ancorawest.wordpress.com/2009/08/ ).  In one blog, I observed that if she wasn’t careful and continued such policies, when the history of this depression is finally written and analyzed, Shelia Bair would be portrayed as a government bureaucrat whose policies and practices deepened the depression.   My colleague and I recently wrote a blog entitled Moral Hazard at the FDIC (TheStreet.com, August 4, 2010) in which we observed that, in the case of the disposition of the failed Corus Bank assets, among others, the FDIC had now become a private sector competitor, had chosen Wall Street partners and provided subsidies to them, and had assumed the role of entrepreneur and risk taker.  We observed through our models that, in the FDIC’s resolution of the Corus Bank assets, only under a significant rise in real estate prices was the recapture of FDIC insurance funds greater than if they just held the assets or sold them at current values.

In a September 8, 2010 Los Angeles Times piece (Downtown L.A. Condo Developer Takes on Investors, FDIC by Roger Vincent) we now learn that the FDIC and the Starwood investor group are fighting with Hassan “Sonny” Astani, a real estate condominium developer in Los Angeles.  In an interview, Mr. Astani stated:  “I face an unholy alliance between government and Wall Street”.

Corus Bank was Mr. Astani’s lender on his condo project in downtown L.A.  When Corus failed, the FDIC stopped funding his project which was 95% complete.  So, Astani auctioned off 77 units he had completed to garner enough cash to finish his 30 story project near the Staples Center.  But, Starwood and the FDIC objected.  According to L.A. City Councilwoman, Jan Perry, this is “a showdown between a local developer trying to finish a big project and high rollers with federal backing determined to grab his $260 million project at a discount”.

Consider the following facts in light of what might be the appropriate behavior of a federal agency:

  • The FDIC, with virtually unlimited Treasury backing, makes a deal with a Wall Street partnership in which the partnership receives a 0% loan and a 1% management fee;
  • The best outcome for the newly formed partnership (FDIC owns a 60% interest) is to hold all of the assets until the real estate markets recover;
  • Because it has a 0% loan, the partnership entity does not want any of the assets to be sold at current prices, so it fights with a developer who appears to be able to save his project from foreclosure.  That is, the partnership entity, because it has no interest carrying costs and gets a 1% management fee, desires to take this property in foreclosure, betting it will be worth much more in the future, and having all the time in the world to wait.

It is quite clear that the FDIC has become a player in the private sector with profit interests competing with, and diametrically opposed to, those of private citizens.  And, with unlimited funding, no taxes to be paid, a 0% cost of capital, and apparently, not answerable to anyone, how can the private citizen compete?

FDIC spokesman Andrew Grey said of this situation: “What we’re trying to avoid is creating the kind of financial incentives that cause the rapid liquidation of the portfolio at fire-sale prices, which could further depress already distressed markets.  The structured transaction enables the FDIC’s managing partner to take a longer-term approach to the loans, allowing for an orderly workout period”.

It’s time for America to wake up to what the FDIC is doing!  Small banks received very little TARP funds, mainly because most of them were filtered through the FDIC which refused, in many cases, to forward small bank TARP applications to the Treasury.  Now, partnering with Wall Street, the FDIC not only unnecessarily discounts the assets they commandeer, but they now  find themselves competing in the private sector and justifying their actions by indicating that their Wall Street partners need “time” for the real estate markets to heal.  Why don’t they give that precious “time” to the five banks they close every week?  As long as they are giving out “time”, such a process would surely result in a better outcome for the FDIC insurance fund since they wouldn’t have to unnecessarily discount assets to attract Wall Street partners.

With unlimited funds, the ability to discount assets to any level they desire, and the capacity to make 0% loans to their Wall Street partners, the FDIC has become an unfair competitor, motivated by greed (the desire for a maximum profit) to the detriment of the private sector and private citizens like Mr. Astani.

Wake up America!  Reform is much needed at the FDIC!

Robert Barone, Ph.D.

September 21, 2010

Statistics and other information have been compiled from various sources.  Ancora West Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.

Ancora West Advisors LLC is a registered investment adviser with the Securities and Exchange Commission of the United States.  A more detailed description of the company, its management and practices are contained in its registration document, Form ADV, Part II.  A copy of this form may be received by contacting the company at: 8630 Technology Way, Suite A, Reno, NV 89511, Phone (775) 284-7778.

September 14, 2010

The Bond Bubble

Posted in Banking, Big Banks, Bonds, Capital, crises, Finance, investment advisor, investments, San Francisco, Uncategorized tagged , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , at 4:35 PM by Robert Barone

The financial press has given credence to those who insist that, because interest rates have fallen rapidly since April, we are in some kind of a bond bubble.  Investors, they say, should shy away from fixed income because, surely, they will be hurt when interest rates rise.  Technically, this statement is correct – the crucial part of the statement is “when interest rates rise”.  If they rise in the near term, then the advice is accurate.  But if they aren’t going to rise for a long time, investors are missing out on valuable and stable returns.  To ascertain the time horizon, consider the following facts:

  • U.S. economic growth has recently turned anemic – from 5.0% in the 4th quarter of ’09, to 3.7% in this year’s 1st quarter, to 1.6% in the 2nd quarter.  Even with the most massive fiscal and monetary stimulus in history, growth appears to be decelerating.  GDP is still lower than it was at the 4th quarter ’07 peak (33 months ago).  This has never happened in post-WWII history.  Interest rates cannot rise under these conditions;
  • With unemployment at 9.6% and at 16.7% when underemployment is counted, and with the economy struggling to create jobs, where will the demand come from that causes businesses to demand funds to expand and cause banks to ration credit by raising rates?  In fact, bank loans have continued to contract since the economic malaise began, and businesses are sitting on the largest hoard of cash in history.  This environment isn’t conducive to rising rates;
  • The American consumer has 130% debt/income ratio, up from a 100% ratio in 2000.  History shows (Rinehart & Rogoff, This Time is Different, Eight Centuries of Financial Folly) that after credit bubbles burst, the consumer debt/income ratio reverts back to its pre-bubble level.  So, we still have a long long way to go.  I suspect that we will eventually get there through a combination of consumer debt repayment and default.   Once again, this is not an environment in which interest rates can rise;
  • Mortgage rates have fallen from over 5% to 4.3%, and still there is little demand.  There is a 12 month inventory of unsold homes at current sales rates, and this doesn’t count the shadow inventory not on the market or the continuing new supply surely to come from a continuing record level of foreclosures.  FNMA is once again offering loans with a $0 down payment!  If they can’t sell these homes with these rates and terms, how can they sell them if rates are rising?;
  • The Fed is talking about a second round of Quantitative Easing (governmentspeak for money printing). Increasing money supply implies a lower, not higher, level of interest rates.  The Fed has also told us that it isn’t going to raise rates for “an extended period”;
  • The “new normal” as PIMCO calls it, is a change in attitudes by the populous toward debt levels and a desire for higher savings and greater frugality.  Such attitude change also occurred in the Great Depression and had a lasting impact on the generation of that time.  Ditto here.  Higher savings increases the supply of lendable funds implying lower, not higher interest rates;
  • Baby boomers, approaching retirement age, have experienced two equity market meltdowns in the last 10 years.  They want more stability in their portfolios and perceive they can achieve that objective with fixed income instruments.  Their portfolios are currently under weighted in bonds.  So, the continuing demand for bonds appears to be strong.

There are two examples in modern history of very long periods of artificially low interest rates.  The first is 1942-1951 when the Fed “pegged” the long-term Treasury rate at 2.5%.  Today, the rate on the 30 year Treasury bond is 3.70%; so there may still be a significant downward move in rates, even from current levels.  The second example is the Japanese experience of the past two decades where interest rates have been similar to what we see today in the U.S.

While the supply of money appears plentiful, should we worry about the demand for our debt declining, thus causing rates to rise to place that debt?  The demand from the Chinese and the rest of the world, we are told by the bond bears, can dry up rapidly and cause our interest rates to rise.  Looking at the data, that has already begun to happen, as China reduced its holding of U.S. Treasury debt in both May and June, yet the 10 year Treasury yield peaked in April and has steadily declined.  With trillions of dollars in cash, no cost to borrow, no appetite for lending, no capital base required to hold Treasury debt, and the promise of low rates for an “extended period” by the Fed, U.S. banks are purchasing all of the debt the Treasury can issue.

Eventually, interest rates will rise.  The question is “when”.  Here are some indicators to watch:

  • Job creation of 200,000 per month and a falling unemployment rate;
  • GDP growth consistently above 3.5%;
  • The debt/income ratio of the American consumer approaching 100%;
  • An upsurge in home sales causing a rise in mortgage rates toward 5%;
  • The Fed eliminating “extended period” from its press releases and FOMC minutes.

None of these appear imminent.  If there is a bond bubble, it is in an early state, and, from the observations above, it appears that it will be quite a while before upward rate pressures appear.

Robert Barone, Ph.D.

September 8, 2010

The mention of securities or types of securities in this article should not be considered as an offer to sell or a solicitation to purchase any securities mentioned.  Please consult an Ancora West Investment Professional on how the purchase or sale of securities can be implemented to meet your particular investment objectives goals.

Statistics and other information have been compiled from various sources.  Ancora West Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.

Ancora West Advisors LLC is a registered investment adviser with the Securities and Exchange Commission of the United States.  A more detailed description of the company, its management and practices are contained in its registration document, Form ADV, Part II.  A copy of this form may be received by contacting the company at: 8630 Technology Way, Suite A, Reno, NV 89511, Phone (775) 284-7778.

September 7, 2010

Fighting the Economic Headwinds

Posted in Banking, Big Banks, Bonds, Capital, crises, Finance, investment advisor, investments, San Francisco, Uncategorized tagged , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , at 6:04 PM by Robert Barone

I have written many blogs about the faltering U.S. economy and the continuing headwinds that will prevail for the next few years.  The headwinds include:

  • A consumer balance sheet loaded with debt with flat to falling income;
  • The  consumer’s major asset, the home, continues to fall in value with approximately 25% of homeowners with mortgages now underwater;
  • A banking system whose lenders to small business, community banks, are constrained by lack of capital and which are under attack by their government regulators insuring a continuing small business credit crunch;
  • The support of the “Too Big To Fail” with cheap capital injections, a bonanza in the arbitrage of borrowing at 0% and purchasing Treasury Notes at a 3.00 percentage point profit margin, while shrinking their lending each and every month.  Meanwhile, they’ve paid themselves outrageous bonuses while Main Street remains mired in Depression;
  • Federal Government economic policies which make the future so uncertain that businesses are reluctant to hire, including:
    • The adoption of healthcare reform against the will of the vast majority of the population with the unintended consequence of a significant increase in the cost of health care and, perhaps, a much poorer delivery system;
    • Interference in, and control of, private sector business including:
      • The government takeover of GM, forcing the firing of its CEO, and protecting 100% of Chrysler’s union pensions at the expense of the bondholders;
      • The passing of a financial reform bill that completely ignored the institutions (FNMA & FHLMC) and Congressional policies responsible for the sub-prime housing bubble, and the establishment of a new government bureaucracy which will, no doubt, make it much more difficult and costly for consumers and businesses to access credit;
      • The use by President Obama of Presidential fiat, against the advice of his own panel of experts, to stop all oil drilling in the Gulf of Mexico which, in my view, will have much more devastating and lasting economic impacts on the region than the oil spill itself;
    • The continuing threat to economic growth of cap-n-trade legislation which has the potential to significantly increase the price of energy.

Americans have now begun to realize that unemployment will be a significant issue for many years.  At the same time, they see that the folks in Washington either will not, or cannot, figure out how to really stimulate private sector job growth.  The U.S. economy cannot expand, and jobs will not be created until investors feel it is safe to invest and businesses feel confident they know the rules of the game and that those rules won’t soon change.

So let’s look at what policy changes are possible to eliminate the uncertainties and bring confidence back.  This will encourage business to take the risk of expansion and result in job creation.  There are 7 such policy changes listed below, 3 of which I will comment on extensively.  As each of these issues are addressed, if, indeed, there is the political will to do so, business confidence will improve and there will be a concomitant improvement in the equity markets:

  1. The Bush Tax Cuts:  It is not a well publicized fact that the net effect of the Bush tax cuts was actually an increase in the marginal tax rates for the wealthy from what they had paid previously.  Yes, the marginal tax rates in the table were reduced, but incomes expanded such that the “rich” (the top 1% of taxpayers) moved up to higher table brackets and actually ended up paying a higher proportion of their income in taxes than they had during the Clinton years (38% vs. 33%) (see Bill Frezza, http://www.realclearmarkets.com/articles/2010/08/16/the_hidden_truth_about_the_bush_tax_increases_98625.html).  The real issue, which has always been obscured by the way the arguments are presented, is not that there isn’t enough tax revenue, it is the explosion in government spending.  Since 1950, federal tax revenues have fluctuated between 16% and 19% of GDP.  And, during the Clinton years, we actually ran a substantial surplus.  Balancing of the federal budget is more about spending control than about lack of revenue.  It’s just easier for the Congress and the politicians to pretend it is a revenue issue and to obscure the real issue by concentrating on the tax issue.
  2. The Credit Crunch – Call off the Regulators: America’s small businesses are in the midst of a credit crunch.  The large, publicly traded corporations, have access to the national debt markets through Wall Street, and have recently taken advantage.  We’ve even seen 100 year bond issues.  Small businesses, on the other hand, don’t have such access and have traditionally relied on community banks and the shadow banking system (non-bank financial institutions) for their borrowing and working capital needs.  It is widely recognized that small businesses in the U.S. create the majority of jobs.  To break the credit crunch, small banks must be able to lend again, or at least be able to make credit available when businesses once again have enough confidence to expand. Under today’s conditions, even if small business wanted to expand, there is no credit available.  In July, Bloomberg News learned that in the case of the Corus Bank (FL) assets (and in 14 other similar cases), the FDIC gave Wall Street firms long-term 0% interest loans.  The FDIC indicated to Bloomberg that they did this to give those Wall Street firms “the time they needed for the Real Estate markets to heal”.  To relieve the credit crunch, why doesn’t the FDIC give the same consideration to small banks, i.e., give them 0% long-term loans to increase their capital, which will give them the same precious time for the Real Estate markets to heal as they are giving to the fat cat Wall Street firms?  A policy of TARP like injections into small banks which will give them both the capital and the time will go a long way to alleviate the credit crunch to small business, making economic expansion and job creation possible when businesses have gained back the confidence they need to expand.
  3. Fix the housing finance system:
  • The first issue is the number of underwater mortgages.  A reduction in the number of foreclosures is critical, yet every month we see these continue to expand.  Using tax policy, mortgage institutions must be encouraged to rework such loans both by lowering the interest rate and by extending the amortization period, even to 40 or 50 years, making these permanent if the homeowner remains current for a specified period.  While this won’t stop all foreclosures (e.g., households without employment), it may lessen them enough to restrict supply such that home prices eventually stop falling;
  • FNMA & FHLMC: These two, alone, have already cost the American taxpayer $150 billion, and the total bill is likely to be north of $500 billion (perhaps, even $1 trillion).  These two entities operated for many years with significant profitability until they were forced by the Congress to enter the sub-prime markets in the late 1990s.  Their original business model isn’t broken, it was changed by Congress.  A return to a public-private partnership with private capital, rational underwriting, a prohibition on lobbying and Congressional political appointments and interference, and run like a business with a board elected by shareholders would go a long way to restoring the housing industry to health;
  • As for the existing FNMA & FHLMC, shut them down and appoint a receiver to wind down their assets (maybe a 20 or 25 year endeavor).  Yes, this will be at great expense to the taxpayer.

Other actions that will have a positive impact on business confidence and on the equity markets (listed without further comments):

  1. Address the Social Security and Medicare unfunded liability issue;
  2. Develop a real energy policy that makes the U.S. energy independent in 15 years;
  3. Stop being the world’s policeman;
  4. Adopt a real immigration plan that stops illegals and encourages foreigners with the skills we need to be competitive in the world to immigrate here and become productive U.S. citizens (who will likely help create jobs).

Each of the above actions will restore some business confidence; several of the actions together will make a significant dent into the unemployment situation; any of these actions will garner a positive reaction from equity investors.

Robert Barone, Ph.D.

August 29, 2010

Statistics and other information have been compiled from various sources.  Ancora West Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.
Ancora West Advisors LLC is a registered investment adviser with the Securities and Exchange Commission of the United States.  A more detailed description of the company, its management and practices are contained in its registration document, Form ADV, Part II.  A copy of this form may be received by contacting the company at: 8630 Technology Way, Suite A, Reno, NV 89511, Phone (775) 284-7778.