October 18, 2011
- Occupy Wall Street – while not a cohesive movement, at least part of its birth can be traced to outsized Wall Street salaries and bonuses, especially since the taxpayer saved most of the TBTF banks. Bank Transfer Day (11/5), the day on which Americans are supposed to transfer their deposits to community banks, is more symbolic than real, as the “Too Big To Fail” (TBTF) banks core consumer deposits are only a small portion of their liabilities and can easily be replaced with no or low cost funding from the Fed or elsewhere. Nevertheless, Bank Transfer Day is a PR issue for the large banks;
- Margin squeeze – TBTF have used the arbitrage spread between borrowing costs (near 0%) and Treasury yields (2%+) to profit. And, the purchase of Treasury securities requires no capital under the capital regulations, as Treasuries are “risk free.” The Fed’s new policy of “Operation Twist” targets longer term interest rates and squeezes this arbitrage spread;
- Volcker Rule – this has recently been put out for comment by the FDIC. It severely limits trading profits made for the bank’s own account and is likely to have a big impact on TBTF trading profits going forward;
- Debit card monthly fees – although such fees are a direct consequence of the limitation on debit swipe fees by the Fed under Dodd-Frank, and it was common knowledge that the TBTF banks would find a way to increase fees elsewhere to make up for their losses on the swipe fees, the timing has turned out to be lousy and the TBTF banks are taking a PR hit from the press, and even from the sponsors of Dodd-Frank who clearly knew that there would be unintended consequences;
- Exposure to Europe – According to Michelle Bachmann, the U.S. TBTF Banks have a $700 billion exposure to European Banks. So, a freezing up of liquidity flows to those institutions may have an impact on the value of such holdings. It is clear that the Fed and the European Central Bank will intervene with massive liquidity injections if such events unfold. Nevertheless, the risk of such a freeze up exists. Furthermore, if contagion spreads because of a Greek default, there is no doubt that the TBTF equities will be negatively impacted. So far, we have seen the equity prices of these behemoths ebb and flow with the news (or hope) out of Europe regarding their evolving “rescue” plan;
- Mortgages & Foreclosures
- Foreclosures at the TBTF institutions are rising because moratoriums have expired and “robo” issues have been addressed. In addition, so called “Prime” loans in portfolios (usually “Jumbo” loans – those that are larger than the FNMA limits) are becoming a big issue as there is a clear trend toward rising “strategic” foreclosures. In fact, Fitch recently downgraded many of these “prime” mortgage pools. This calls into question the quality of what may be on the TBTF balance sheets in the form of such jumbo loans. Furthermore, the fact that FNMA and FHLMC reduced their loan maximums on October 1st is destined to have a huge negative impact in states like CA and FL, where the prices of higher end properties will fall due to the unavailability of financing. So, expect “strategic” defaults to rise rapidly in these states;
- Half of America’s mortgages are on MERS (Mortgage Electronic Registration System), but, in many states, MERS has no standing in foreclosure. Theoretically every owner of a securitized pool should sign off on each foreclosure in the pool. There could be hundreds, if not thousands, of owners in these pools. In addition, many jurisdictions require that title transfers be recorded in county recorder offices. Since that did not occur, lawsuits are now being developed against the major TBTF players for lost recording/title transfer fees. The Dallas DA recently sued MERS and BAC for $100 million of such fees. According to Mark Hanson, since MERS has been operating since 1995, there could be billions of dollars of such thwarted fees. Because nearly every local governmental entity is hungry for funds, this could catch on like wildfire;
- Bank of America’s (BAC) $8.6 billion global servicer settlement is in trouble, as NY’s AG Schneiderman says it should be closer to $25 billion, and he is getting support from other states, like CA. The rumor mill has circulated the theory that if lawsuit settlements become outsized, BAC appears to have the option of bankrupting the old Countrywide unit, which it has kept as a separate legal entity since its purchase in 2008. Imagine, though, the market reaction to such a move!
- Lawsuits on mortgage trustees are just starting. According to Bloomberg, US Bank, Bank of NY Mellon, Deutsche Bank, Wells Fargo, HSBC, BAC and Citibank (C) are the major mortgage trustees. Bloomberg speculates that since these institutions didn’t underwrite, sell, securitize, service, or ship loans according to regulations, the odds are low that the trust departments got it right. So far, NY’s Schnedierman has requested documents from Deutsche Bank and Bank of NY Mellon.
- In early September the Federal Housing Finance Agency (FHFA), the receiver for FNMA and FHLMC, sued BAC, C, JPMorgan Chase (JPM), Barclays, HSBC, Credit Suisse, and Noruma Holdings demanding refunds from these institutions for loans sold to FNMA and FHLMC that were based on false or missing information about the borrowers or the properties. The FHFA said that the two mortgage giants purchased $6 billion from BAC, $24.8 billion from Merrill Lynch which is now owned by BAC, and $3.5 billion from C.
- Lawsuits and foreclosure issues are making the TBTF banks sorry they are in the mortgage business. JPM’s Dimon announced that they are going to be leaving the mortgage business, and BAC announced last week that by year’s end they will stop buying mortgages from correspondents.
Not all of this appears to be priced in the market, so there may be continued downward pressure on the prices of financial stocks, especially TBTF, as events unfold, especially the potentially disruptive forces that Europe may unleash, or the conclusion that the foreclosure and mortgage lawsuits are larger and more significant than currently believed.
Robert Barone, Ph.D.
October 12, 2011
|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 “Firm Brochure”, (Form ADV, Part 2A). A copy of the Brochure may be received by contacting the company at: 8630 Technology Way, Suite A, Reno, NV 89511, Phone (775) 284-7778|
October 10, 2011
Despite a preponderance of evidence, the markets continue to rely on the “hope” that Europe will solve its enormous financial issues, that the U.S. will somehow miraculously begin to grow at or above GDP potential, and that the emerging markets will continue to grow by exporting to the developed world. There are those on Wall Street still pushing “buy and hold” indicating to clients that, based on forward earnings forecasts, the equity markets look cheap, as if those forward forecasts aren’t subject to downward revisions. Thus, the “buy and hold” is really “buy and hope.” There are no quick fixes to any of the economic problems so evident in a world awash in debt.
- Europe is clearly entering a recession, and is likely to be in it for an extended period.
- The value of the sovereign debt of the European periphery countries is a huge issue. Greece can afford to pay “normal” interest rates on about 20%-30% of its current debt. Therefore, when its inevitable default occurs (looks like soon), the haircut on its external debt may be as high as 80%. Once the default is announced, the markets will pounce on the next weakest – at this time, that looks like Italy, although Portugal and Spain are also in the race.. To keep Italy from defaulting, the Troika (the European Union (EU), the European Central Bank (ECB), and the International Monetary Fund (IMF)) may have to finance Italy’s deficit and purchase its debt rollover for as many as 3 years. The rollover of central government debt alone is €705 billion. The regional debt is also significant. The risk is that Germany or one of the other 17 European Monetary Union (EMU) members balk.
- The real issue revolves around the European financial system. There isn’t enough capital in it to mark the sovereign debt they hold on their books to market values. The haircuts given to the peripheral sovereign debt when a Greek default occurs will cause an ugly reaction in the financial markets. Huge liquidity infusions from the ECB (and likely the Fed) will be required. Morgan Stanley says that €140 billion in new capital is needed, but I have seen estimates as high as €800 billion.
- Discussions among Europe’s finance ministers about using the European Financial Stability Fund (EFSF) as a Special Purpose Vehicle to provide liquidity or to provide capital to the banking system (the discussion seems to change on a daily basis) have caused the financial markets to rise on such hope. As far as I can tell, the €780 billion of capital that is being voted upon by the 17 EMU members (14 have approved so far) could be used as capital to lever up to higher levels and use the resulting funding for either or both liquidity and capital.
- This is all still in discussion stage. Somehow, Greece miraculously found funds to keep itself solvent until mid-November, so the European finance ministers have kicked the can down the road for another month. The real risk here is whether or not the Europeans can agree. History is not on their side. Unlike the U.S., the EMU requires unanimous consent and monetary contributions from each of its 17 members to cope with unusual circumstances not envisioned in the EMU treaties. Malta and Cyprus have the same veto power as Germany. It should be noted that, as of this writing, the Slovakia vote on an expanded EFSF is not a sure thing, and that Finland received special guarantees for its approval vote. Imagine the chaos if every small member demanded special treatment – it could look like the earmark system used in the U.S. Congress.
- Italy was recently downgraded 3 notches by Moody’s, from Aa2 to A2 with a negative outlook. The Credit Default Swap (CDS) market believes Italy is still significantly overrated, as is most of the rest of Europe. CDS may not be the best indicator of financial stability, but it appears that there are enough skeptics on European sovereign debt to make investors wary. If much of Europe eventually gets downgraded, what kind of rating will the EFSF’s debt have?
- In its current form, the EFSF must wait for a support request from a member country, and then must get unanimous consent from the 17 finance ministers. (I smell gamesmanship in the form of holdout for special concessions – just like Finalnd!)
As you can see, the machinery is quite cumbersome and very slow to act. Things must go flawlessly for Europe to avoid significant calamity over the next few quarters. The excitement recently seen in the equity markets appears to be based on hope – not a very reliable investment strategy.
Japan and the Emerging Markets
- Japan has too much debt coupled with deteriorating demographic trends. Since the 1990s, they have not addressed the issues on their banks’ balance sheets, and real estate prices (land) have continued to decline for those two “lost” decades. Their August industrial production numbers were weaker than expected. Don’t look for Japan to lead. Their two decaded economic malaise may, in fact, be what is in store for Europe and the U.S.
- There are also troubling signs in China and the emerging markets (BRICS). HSBC’s PMI index for China has been below 50 for three consecutive months (below 50 implies contraction). Whatever the case, growth is clearly cooling, most likely indicating some success in China’s fight against rising inflation, especially in real estate where prices are now flat to falling. This, of course, is having a significant impact on natural resource and commodity prices.
- It is unlikely that China, which still has positive, but slower, growth, will repeat the stimulus package they unleashed in ’09. That helped the rest of the world climb out of recession. The rapidly falling prices of industrial commodities (e.g., copper) is symptomatic of the slower pace of growth in the emerging world.
- Some emerging markets, like Brazil, which have been fighting the inflation caused by the influx of capital from the developed world, are now seeing declining growth rates, most likely due to the slowing growth in the developed world which has a huge impact on emerging world exports and prices.
United States Housing Market
- Housing normally leads the U.S. economy into recession, and then leads it out. Not so this time. Housing issues are getting worse, not better. Prices, especially those of higher end homes, continue to fall, even with mortgage rates at historic lows (below 4% for 30 year fixed). Qualifying is now extremely difficult and requires a large down payment. On October 1, FNMA and FHLMC lowered the maximum amounts they will lend. Since they purchase over 90% of all new loans made, this will significantly lower sales volumes, and eventually prices, in high priced areas like California.
- Foreclosure trends are on the rise, both because the financial institutions have worked their way through the “robo” signing issues, and because most foreclosure moratoriums have expired. Given the sorry state of housing, more and more underwater homeowners are simply giving up on ever seeing positive equity again. “Strategic” defaults are on the rise. These occur when a homeowner who can afford the payments walks away because the mortgage balance is significantly higher than the home’s value, and the owner believes it will be years, if ever, before he breaks even. As a result, Fitch has recently lowered the ratings on what used to be called “prime” mortgage loans causing some dislocations in mutual and hedge funds that specialize in holding such non-agency paper, especially the ones that also use leverage.
- Lawsuits are proliferating around mortgage issues. The Mortgage Electronic Registration System (MERS), a private corporation with about 50 employees, claims to hold title to about half of the mortgages in the U.S. They have filed foreclosure actions on behalf of the mortgage “owners” (there could be several hundred or even thousands of owners of a securitized pool). Many jurisdictions require the “owner” to file the foreclosure. Imagine having to get signatures of everyone that owns a share of a securitized mortgage pool each time one of the mortgages in the pool goes into default. In addition, many jurisdictions require that title transfers be recorded in county recorder offices. Since that did not occur, lawsuits are now being filed against major private sector mortgage purveyors (like JPM, or WF) for lost recording/title transfer fees. The Dallas DA recently sued MERS and BAC for $100 million. According to Mark Hanson, since MERS has been operating since 1995, there could be billions of dollars of such thwarted fees.
- Mortgage trustees are also not immune from lawsuits. According to Bloomberg, US Bank, Bank of NY Mellon, Deutsche Bank, Wells Fargo, HSBC, Bank of America, and Citibank are the major mortgage trustees. Bloomberg speculates that since these institutions didn’t underwrite, sell, securitize, service, or ship loans according to regulations, the odds are low that the trust departments got it right. So far, NY AG Schneiderman has requested documents from Deutsche bank and Bank of NY Mellon.
- The $8.6 billion mortgage servicer settlement that Bank of America thought was a done deal has now fallen apart. NY’s AG, Schneiderman thinks that the settlement should be closer to $25 billion.
- With all of the lawsuits and the state of housing, the large mortgage originators are sorry they are even in the business. Jamie Dimon recently announced that JPMorganChase may be leaving the business. In early October, Bank of America announced they would stop their correspondent mortgage business by year’s end, which means that they won’t be buying mortgages originated by others. One more nail in housing’s coffin.
So, let’s review: 1) Home prices continue to fall; 2) FNMA and FHLMC lowered their loan maximums; 3) Foreclosures are rising; 4) Lawsuits are proliferating on private sector lenders; 5) large private sector lenders are either leaving the business or curtailing it. So, how is it that housing can lead the way out of the economic funk?
Other U.S. Indicators
- 70% of GDP in the U.S. is from consumption. The fact that real consumer income (after inflation) has fallen for three months in a row and is no higher than it was in 1997 is a very troubling sign because credit can no longer be used to consume. In the months in which we actually see consumption rising, we see the savings rate fall. Increasing consumption in an economy with falling consumer income can only last as long as there is savings. So, it can only be a short-run phenomenon.
- Washington, D.C. finds it impossible to come to terms with their overspending. Nothing they have done, including the $1.5 trillion “Supercommittee” mandate will make a dent in the entitlement spending increases coming at us like a speeding train. We know no changes in the entitlement rules will occur before 2013, at the earliest.
- What is occurring at the Federal, State and Local levels is significant belt tightening. President Obama’s Jobs Bill was DOA in Congress. Because of the tax increases proposed, the Democrats even had a difficult time in finding a sponsor to introduce the bill. With the funds provided in the ’09 stimulus package now gone, with a Congress not interested in more tax and spend, and with the Fed now out of real ammunition, there isn’t going to be much government help for a weakening economy.
- Sarbanes-Oxley, Dodd-Frank, Obamacare, EPA pronouncements, other regulatory burdens, the uncertainty surrounding taxes and tax rates etc. has led to an environment of business uncertainty. Under such conditions, there is virtually no chance that labor markets will pick up anytime soon. As a result, consumer confidence continues to bounce along well below traditional recessionary levels.
The preponderance of the evidence makes it clear that the risks in the equity markets are to the downside. There are no quick fixes to any of the European or U.S. problems. Europe’s financial issues can easily morph into a worldwide financial panic. The U.S.’s housing, deficit, and employment issues will linger without a new approach, one that we won’t see until at least 2013. Safety is clearly a better investment strategy than hope.
Robert Barone, Ph.D.
October 10, 2011
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 “Firm Brochure”, (Form ADV, Part 2A). A copy of the Brochure may be received by contacting the company at: 8630 Technology Way, Suite A, Reno, NV 89511, Phone (775) 284-7778.
October 3, 2011
In the last quarter century, each and every time politicians have “kicked the can down the road” in order to buy time to protect their banks (with the false hope that there will be a “Deus ex Machina,” i.e., a miracle), the resulting pain is much worse than if the problem had been addressed head on and resolved, even if painful at the time. You can look at this in many ways, including the deficit and entitlement issues in the U.S. But, I am going to limit myself to the financial realm in this particular essay.
Kick the Can: The S&Ls
In 1984, I gave a presentation to a group of senior citizens regarding what I saw as the insolvency of the S&L industry. In social conversations, my wife often recalls the reactions of many of those seniors, many of whom had Certificates of Deposit at S&Ls (back then, interest rates were significantly higher than today’s paltry rates). I suspect that the local heart specialists were busier than usual the next day.
The S&L can was kicked down the road for five more years. It wasn’t until a new President (Bush #1) was inaugurated that the problem was addressed – that was 1989. By then, the problem was significantly larger than it was in 1984 when even I could recognize the issue. Because the can was kicked for five years, America went through an unnecessary and grueling recession in the early ‘90s, in which the financial system teetered and required government intervention. Truth be told, however, the allowance of the S&Ls to abuse deposit insurance (or at least not appropriately pay for the risk they were layering onto the insurance system) and lack of oversight by the regulators (sound familiar?) should take much of the blame. However, by ’89 the crisis was addressed, S&Ls were closed, and the bad loans on their books were dealt with. Because the bad loans were written off, the financial system stabilized and enabled the economy to grow and prosper for much of the rest of the decade.
Kick the Can: Japan’s Banks
At about the same time (1989) Japan’s bubble burst. In 2002, then Fed Governor Bernanke, criticized the Japanese approach to their banking issues in a famous speech about how the Fed would not let a Japan style deflation happen in the U.S. Beginning in 1989, the Japanese regulatory agencies did not, and to this day, have not required Japan’s banks to recognize the losses on their underwater real estate loans. When banks get into a position of knowing they have problem assets, they become quite reluctant to expand their loan portfolios and take on new risk. Oftentimes, the regulators, recognizing that they have dropped the ball in the first place, become overbearing and shackle the banking system. More than two lost decades later, Japan’s real estate (land) prices are still falling, and economic growth remains sluggish, intermixed with frequent bouts of recession.
Kick the Can: Too Big To Fail
The financial crisis in the U.S. in ’09 was also met with can kicking. The “Too Big To Fail” (TBTF) banks that were allowed too much leverage in the period leading up to the crisis were all saved with taxpayer dollars. This time, however, the problems were not met head on as they were in ’89. In fact, Dodd-Frank has now codified TBTF – those institutions are now called SIFIs, Systemically Important Financial Institutions. And, America’s banks are back to playing the leverage game, this time with complicity from Washington, which depends on them to purchase newly issued debt. By the way, that debt requires no underlying capital, an issue we will see later in this essay that has come to the forefront in Europe. In the ’09 crisis, the shadow banking system (non-deposit taking lenders) was destroyed, and because the remaining small business lenders, America’s community banks, still have major asset issues, small business lending has dried up. Today, as in Japan, economic growth is sluggish and the economy continuously flirts with recession. (I can’t blame all of the sluggishness in small business lending on the supply side because clearly the demand for small business loans is down due to the uncertain economic outlook that pervades America today.)
Kick the Can: Save the Bondholders
One major mistake of Japan, and of the so-called solution to the ’09 financial crisis, is that bondholders of most of these failing institutions, who took the risk of their investments, have not been asked to take the losses. Except for FNMA and FHLMC, even the preferred shareholders of the failed megabanks (Wachovia, Washington Mutual, Merrill Lynch) were saved. Why was it so important to save these stakeholders? Did we really fall for the concept that if their bondholders lost money, then the economy would totally collapse?
Kick the Can: European Bank Stress Tests
Today, Europe’s banks are teetering on the edge. This past Spring’s round of “stress tests” were a joke meant only to assuage the markets. The sovereign foreign holdings of Greek, Irish, Portuguese, Spanish and Italian debt were all counted at par with zero capital required against these assets. It is clear that the European banks are in desperate need of capital, and the shutting down of calls for such capital from knowledgeable and respected individuals doesn’t really fool anyone. So, why are the Europeans about to throw good money after bad in a futile attempt to keep Greece from defaulting, and, once again, kicking the can down the road?
By forcing further “austerity” on the Greek economy in order to give them enough aid to pay the upcoming round of bond maturities at par, and therefore “saving” those particular bondholders, they are just prolonging the whole issue. Even more austerity will further undermine the Greek economy causing ever widening deficits. So, why are the bondholders so sacred? The answer, of course, is that the European banks hold huge positions in the sovereign debt of Greece and the other high debt European Monetary Union (EMU) nations.
Kick the Can: Liquefy European Banks
With huge volumes of such debt on their books, each financial institution has become leery of its brethren, and interbank lending has begun to dry up. As a result, The Fed, the European Central Bank (ECB), the Swiss national Bank, the Bank of England, and the Bank of Japan, in a coordinated effort in mid-September, began making dollar swap lines available to the European banks. It appears that the Fed is involved because of Bernanke’s view of the Fed as the world’s central bank, and because of the fact that the vast majority of America’s money market funds hold large amounts of European bank commercial paper or other debt as assets. Thus, instability of the European banking system could potentially touch off another credit market freeze in the U.S. and worldwide. Yet, despite these interventions, within a week those very same liquidity strains have begun to re-emerge.
Kick the Can: Greek Default Inevitable
In the end, a Greek default is inevitable. The math on this is too compelling. Even if Greece could balance their budget pre-debt service, the debt service cost alone, even at reasonable interest rates, doom them to years of depression. For Greece, default is really the best road.
Default is also better for the rest of the EMU. Better to use the funds that are now going to pay off bondholders of Greek debt at par to help recapitalize Europe’s banks. In the long run, this is cheaper and it addresses the underlying issue, European bank capital.
As for Greece, they, and even the other weaker EMU countries, can go back to their own currencies, and, if they so choose, peg them to the Euro. If they run large fiscal deficits, the pegs can always be adjusted.
Dealing with Greek Default
A Greek default, of course, risks a financial panic in the markets. To deal with such contagion, the ECB or the EFSF (European Financial Stability Fund) or some pan-European or international entity with credibility, should specify which countries are Tier I EMU countries, which are Tier II (Italy and Spain),and which are Tier III (Greece, Portugal, Ireland). Tier III countries should be planning an imminent, but orderly, exit from the EMU with ECB and EFSF support of their bonds at some price well below par. Tier II countries should be given some time and support (in the form of an ECB or the EFSF bond purchase program at par) to get their fiscal houses in order.
The inevitable Greek default is going to have a worldwide impact even if done in an orderly, thoughtful, and coordinated way. (If not planned properly, expect very high volatility in the financial markets.) And financial institutions in the U.S. will not be spared the effects of such a default. If the European banks appear in danger, U.S. money market funds, and very likely some of the SIFIs with loans to European banks, will be hard hit by market action. We have already seen the beginnings of this.
More Capital – the Reason for Basle III
It should be obvious by now that many of the largest worldwide banks need more capital. Yes, even those in America. (Consider the recent BAC denial of its need only to obtain capital within a week of the denial!) The need for capital is why we have Basle III. Unfortunately, the Basle III timeline is too lengthy, as the capital is needed now. Without new capital, much of the developed world will suffer the fate that Japan has suffered over the past two decades and now present in the U.S., with banks too worried about capital levels to want to take on additional risk in the form of business loans. Well-capitalized banks at least remove the constraint of loan availability when conditions are right for economic growth.
Robert Barone, Ph.D.
September 26, 2011
|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 “Firm Brochure”, (Form ADV, Part 2A). A copy of the Brochure may be received by contacting the company at: 8630 Technology Way, Suite A, Reno, NV 89511, Phone (775) 284-7778.