by Calculated Risk on 2/11/2009 03:55:00 PM

Excerpts from Martin Wolf: Why Obama’s new Tarp will fail to rescue the banks

All along two contrasting views have been held on what ails the financial system. The first is that this is essentially a panic. The second is that this is a problem of insolvency.

Under the first view, the prices of a defined set of “toxic assets” have been driven below their long-run value ... The solution, many suggest, is for governments to make a market, buy assets or insure banks against losses. ...

Under the second view, a sizeable proportion of financial institutions are insolvent: their assets are, under plausible assumptions, worth less than their liabilities.
...
Personally, I have little doubt that the second view is correct and, as the world economy deteriorates, will become ever more so. But this is not the heart of the matter. That is whether, in the presence of such uncertainty, it can be right to base policy on hoping for the best. The answer is clear: rational policymakers must assume the worst. If this proved pessimistic, they would end up with an over-capitalised financial system. If the optimistic choice turned out to be wrong, they would have zombie banks and a discredited government. ...

Why then is the administration making what appears to be a blunder? It may be that it is hoping for the best. But it also seems it has set itself the wrong question. It has not asked what needs to be done to be sure of a solution. It has asked itself, instead, what is the best it can do given three arbitrary, self-imposed constraints: no nationalisation; no losses for bondholders; and no more money from Congress. Yet why does a new administration, confronting a huge crisis, not try to change the terms of debate? This timidity is depressing.
...
The correct advice remains the one the US gave the Japanese and others during the 1990s: admit reality, restructure banks and, above all, slay zombie institutions at once. ...

By asking the wrong question, Mr Obama is taking a huge gamble. ... He needs to rethink, if it is not already too late.

It is very important that the bank stress tests be completed quickly (within 30 days), and the results made public. This will help remove some of the uncertainty, and might make it clear whether or not the U.S. needs to preprivatize (a kinder term for nationalize) the banks.

by Calculated Risk on 2/11/2009 02:06:00 PM

From MarketWatch: U.S. Jan. budget deficit $84.0 bln vs $17.8 surplus yr-ago

The government reported a deficit of $84.0 billion in January ... [compared to] a surplus of $17.84 billion in the same month one year ago. Lower corporate taxes are dragging receipts lower, while spending has jumped ... Experts are forecasting a deficit above $1.6 trillion in the fiscal year ending Sept. 30

The CBO was projecting a deficit of $1.2 trillion before the Obama stimulus plan:

As for the startling [$1.2 trillion] estimate from the nonpartisan Congressional Budget Office, if it proves accurate, the budget deficit will be nearly two and a half times bigger than the previous record shortfall of $455 billion reached in 2008.

The estimate was far higher than most other analysts have predicted. If combined with the gigantic stimulus package of tax cuts and new spending that Mr. Obama is preparing, which could amount to nearly $800 billion over two years, the shortfall this year could hit $1.6 trillion.

And it is important to note that this is the unified budget deficit that includes the significant Social Security Insurance surplus. The General Fund deficit will be even worse.

by Calculated Risk on 2/11/2009 11:20:00 AM

Update: CNBC: Tentative Accord Reached On Smaller Stimulus Plan

The White House and key congressional negotiators have tentatively settled on a $790 billion price tag for President Barack Obama's economic recovery plan, Democratic aides on Capitol Hill said.

The aides said one way negotiators are trimming the measure's cost below the $838 billion plan that passed the Senate Tuesday is to pare back Obama's signature "Making Work Pay" tax credit for 95 percent of workers.

This should be cut to $400 a year instead of $500. A married couple would get $800 instead of the $1,000 initially proposed by Obama.

Update: WSJ: Deal Nears on Stimulus Plan

Under the framework coming together, lawmakers would trim the cost of Senate-approved tax cuts intended to spur auto and home sales, but would preserve a measure intended to shield millions of middle-income Americans from the alternative minimum tax, a levy originally designed to hit the wealthy.

Among other things, a signature Obama tax cut—the payroll tax holiday for workers –would be scaled back, under the framework being negotiated.

One headlines says "reach", the other "near" ... It sounds like a deal is close, and the stimulus package will likely be smaller than either the House or Senate versions.

by Calculated Risk on 2/11/2009 09:30:00 AM

Click on graph for larger image.

This graph shows the Mortgage Bankers Association Commercial/Multifamily Mortgage Originations index since 2001.

From the Mortgage Bankers Association (MBA): Commercial/Multifamily Mortgage Originations Down 80% from Q4 2007 in MBA Survey (hat tip Robert)

Commercial and multifamily mortgage loan originations dropped in the fourth quarter, according to the Mortgage Bankers Association's (MBA) Quarterly Survey of Commercial/Multifamily Mortgage Bankers Originations. Fourth quarter originations were 80 percent lower than during the same period last year. The year-over-year decrease was seen across all property types and investor groups.

"Commercial and multifamily mortgage lending slowed to a trickle in the fourth quarter," said Jamie Woodwell, Vice President of Commercial Real Estate Research at the Mortgage Bankers Association. "Origination levels in the fourth quarter were 80 percent below last year's fourth quarter, and originations for all of 2008 were down approximately 60 percent from 2007 levels. Between the worsening economy and the continued credit crunch, lenders are extremely cautious about lending and borrowers are likely to hold onto the assets and the loans they already have."

Decreases in total commercial/multifamily mortgage originations continued to be led by a drop in commercial mortgage-backed security (CMBS) conduit loans and loans for commercial bank portfolios. ...

The decrease in commercial/multifamily lending activity during the fourth quarter was driven by decreases in originations for all property types. When compared to the fourth quarter of 2007, the overall 80 percent decrease included a 99 percent decrease in loans for hotel properties, an 82 percent decrease in loans for retail properties, a 76 percent decrease in loans for industrial properties, a 72 percent decrease in loans for office properties, a 62 percent decrease in multifamily property loans, and a 47 percent decrease in health care property loans.

For more details, here is the quarterly report.

by Calculated Risk on 2/11/2009 08:36:00 AM

The big trade story is the continuing sharp decline in both imports and exports.

The Census Bureau reports:

[T]otal December exports of $133.8 billion and imports of $173.7 billion resulted in a goods and services deficit of $39.9 billion, down from $41.6 billion in November, revised. December exports were $8.5 billion less than November exports of $142.3 billion. December imports were $10.2 billion less than November imports of $183.9 billion.

Click on graph for larger image.

The first graph shows the monthly U.S. exports and imports in dollars through December 2008. The recent rapid decline in foreign trade continued in December. Note that a large portion of the decline in imports is related to the fall in oil prices - but not all.

The second graph shows the U.S. trade deficit, both with and without petroleum through December.

The blue line is the total deficit, and the black line is the petroleum deficit, and the red line is the trade deficit ex-petroleum products.

Import oil prices fell to $49.93 in December, although import quantities increased in December - so the petroleum deficit only declined slightly. Import oil prices will probably fall further in January.

Excluding petroleum, the trade deficit has been falling since early 2006. The rebalancing of trade continues, although the sharp declines in both imports and exports is very concerning.

by Calculated Risk on 2/11/2009 02:12:00 AM

From Bloomberg: Credit Suisse Reports SF6.02 Billion Loss on Trading

Credit Suisse Group AG, Switzerland’s second-biggest bank, reported a 6.02 billion Swiss-franc ($5.2 billion) fourth-quarter loss on wrong-way trading bets and costs tied to cutting jobs and selling part of its fund unit.
...
“We have had a strong start to 2009 and were profitable across all divisions year to date,” [Chief Executive Officer Brady] Dougan said in a statement. “We have positioned our businesses to be less susceptible to negative market trends if they persist in the coming months.”

Another visit to the confessional.

by Calculated Risk on 2/10/2009 09:10:00 PM

The House and Senate stimulus bills are significantly different, and finding a compromise will probably be difficult.

From the WSJ: Obama Seeks to Restore Spending to Stimulus Plan

The White House is seeking to restore funding cut by the Senate for schools, health insurance and computerizing health records as the economic-stimulus plan heads for a final round of negotiations in Congress this week.
...
To make room for added spending, the White House, joined by House Democratic leaders, is pressing to scale back certain Senate-passed tax breaks, including ... an $11.5 billion proposal to give car buyers a tax deduction covering local sales taxes and interest on auto loans, and a $35 billion proposal to create a new tax credit for home purchases.

The $35 billion tax credit is probably the least useful provision in the Senate stimulus bill.

Here is one of my posts on this provision: The Homebuyer Tax Credit

And here is Professor Kash Mansori on the impact of the tax credit on house prices: Will a Home Purchase Tax Credit Help Boost House Prices?

This tax credit will not stabilize house prices, has very limited stimulative impact, and it will mostly go to home buyers who would buy anyway. Hopefully it will be removed in conference.

by Calculated Risk on 2/10/2009 05:34:00 PM

Terry Moran at ABC News interviewed President Obama today (airs tonight). Here are some excerpts: (hat tip Paul Kedrosky)

TERRY MORAN: There are a lot of economists who look at these banks and they say all that garbage that's in them renders them essentially insolvent. Why not just nationalize the banks?

PRESIDENT OBAMA: Well, you know, it's interesting. There are two countries who have gone through some big financial crises over the last decade or two. One was Japan, which never really acknowledged the scale and magnitude of the problems in their banking system and that resulted in what's called "The Lost Decade." They kept on trying to paper over the problems. The markets sort of stayed up because the Japanese government kept on pumping money in. But, eventually, nothing happened and they didn't see any growth whatsoever.

Sweden, on the other hand, had a problem like this. They took over the banks, nationalized them, got rid of the bad assets, resold the banks and, a couple years later, they were going again. So you'd think looking at it, Sweden looks like a good model. Here's the problem; Sweden had like five banks. [LAUGHS] We've got thousands of banks. You know, the scale of the U.S. economy and the capital markets are so vast and the problems in terms of managing and overseeing anything of that scale, I think, would -- our assessment was that it wouldn't make sense. And we also have different traditions in this country.

Obviously, Sweden has a different set of cultures in terms of how the government relates to markets and America's different. And we want to retain a strong sense of that private capital fulfilling the core -- core investment needs of this country.

And so, what we've tried to do is to apply some of the tough love that's going to be necessary, but do it in a way that's also recognizing we've got big private capital markets and ultimately that's going to be the key to getting credit flowing again.

Kedrosky comments:

[S]aying that Sweden had five banks and the U.S. has thousands, so nationalization can’t happen here, is misleading. It ignores the relative GDPs of the two countries. ...[and] the problem is chiefly in the six largest U.S. banks ...

On the issue of "cultural differences" between the U.S. and Sweden, I've joked that we should call taking over the banks "preprivatization" to avoid the stigma of "nationalization".

But stop and think about what Obama is saying. We know the correct answer, but we are afraid to do it - because of our "culture" - so we are going to follow the Japanese plan.

We should definitely stress test the banks. My suggestion: announce when this will be complete (within 30 days), make the results public, and preprivatize the insolvent ones.

Update: Roubini: It Is Time to Nationalize Insolvent Banking Systems. Excerpt:

[W]hy is the US government temporizing and avoiding doing the right thing, i.e. take over the insolvent banks? There are two reasons. First, there is still some small hope and a small probability that the economy will recover sooner than expected, that expected credit losses will be smaller than expected and that the current approach of recapping the banks and somehow working out the bad assets will work in due time. Second, taking over the banks – call is nationalization or, in a more politically correct way, “receivership” – is a radical action that requires most banks be clearly beyond pale and insolvent to be undertaken. Today Citi and Bank of America clearly look like near-insolvent and ready to be taken over but JPMorgan and Wells Fargo do not yet. But with the sharp rise in delinquencies and charge-off rates that we are experiencing now on mortgages, commercial real estate and consumer credit in a matter of six to twelve months even JPMorgan and Wells will likely look as near-insolvent (as suggested by Chris Whalen, one of the leading independent analysts of the banking system).

Thus, if the government were to take over only Citi and Bank of America today (and wipe out common and preferred shareholders and also force unsecured creditors to take a haircut) a panic may ensue ... Instead if, as likely, the current fudging strategy - of temporizing and hoping that things will improve for the economy and the banks - does not work and in 6-12 months most banks (the major four and the a good part of the remaining regional banks) all look like clearly insolvent you can then take them all over, wipe out common shareholders and preferred shareholders and even force unsecured creditors to accept losses ( in the form of a conversion of debt into equity and/or haircut on the face value of their bond claims) as the losses will be so large that not treating such unsecured creditors would be fiscally too expensive.

So, the current strategy – Plan A - may not work and the Plan B (or better Plan N for nationalization) may end up the way to go later this year. Wasting another 6-12 months to do the right thing may be a mistake but the political constrains facing the new administration – and the remaining small probability that the current strategy may by some miracle or luck work – suggest that Plan A should be first exhausted before there is a move to Plan N. Wasting another 6-12 months may risk turning a U-shaped recession into an L-shaped near depression but currently Plan N is not yet politically feasible.

by Calculated Risk on 2/10/2009 03:56:00 PM

Update: This graph is from Doug Short of dshort.com (financial planner): "Four Bad Bears". There is much more at the site.

Click on graph for updated image in new window.

Note that the Great Depression crash is based on the DOW; the three others are for the S&P 500.

Investors didn't think much of Secretary Geithner's outline of a bailout (we can't really call it a plan).

DOW off 386 points or so ...

S&P 500 off 43 points (almost 5%)

NASDAQ off 67 points (about 4%)

Another day of Cliff Diving.

by Calculated Risk on 2/10/2009 01:53:00 PM

One of the key elements of the Financial Stability Plan is to build "Financial Stability Trust" by conducting "A Comprehensive Stress Test for Major Banks" and providing investors and the public "Increased Balance Sheet Transparency and Disclosure".

Although lacking in details, this is a very good idea. A few suggestions:

Provide a timeline for conducting the stress tests of all institutions with more than $100 billion in assets (like 30 days).

Disclose the results with multiple scenarios on the Financial Stability website by bank (yes, name each bank and the future projected losses under each scenario).

A template for this disclosure could be the JPM presentation when they acquired WaMu.

Here is the table JPM provided:

Click on chart for larger image in new window.

JPM presented the WaMu losses from three scenarios: a base case (with national prices falling 25% peak to trough), a deeper recession (28% decline), and a severe recession (37% decline).

Although unemployment will probably exceed the JPM severe recession scenario of 8% - the point is investors now know that! We can see that in the severe recession, JPM expected national house prices to decline 37% and 54% in California. This would lead to an estimate $54 billion in additional losses.

Note: the toxic assets are frequently described as difficult to value, but the real problem is forecasting future defaults. This is why providing different scenarios for the stress test makes sense. No one has a crystal ball. For mortgage related assets, defaults correlate well with house price declines - so the JPM method is very useful. For other assets (like automobiles), unemployment is a better measure.

A table like this would allow investors and the public to understand which institutions are insolvent under different scenarios, and then provide a guide for the Capital Assistance Program (aka more capital injections). If a bank is massively insolvent, then the next step would be preprivatization. At least we would all know.

If JPM could put this data together in fairly short order, the other institutions - under the supervision of the government - could provide this data within 30 days. One of the key roles for the government would be to make sure the analysis is consistent between institutions: same scenarios, same defaults per house price declines, same results for similar securities.