Sense on Cents

Democracy Likely Defeats Moral Hazard

Posted by Larry Doyle on April 20th, 2009 7:06 PM |

As part of Obama’s proposal to support housing, the administration pushed the application of principal reduction via bankruptcy proceedings. This process, known as a mortgage cram-down, was pushed hard by the administration and many Democrats. Virtually all Republicans and mortgage investors viewed the mortgage cram-down as another in a long line of moral hazards. In short, the mortgage cram-down would violate the implicit and explicit terms of a written contract.

I wrote What Is a Mortgage Cram Down? on January 1st. While the Obama administration pushed hard for this legislation to be approved, ultimately those with a longer term vision prevailed. What are the concerns about principal reduction? As I wrote:

I personally find it difficult to swallow the concept of government funding for this program. At this juncture, though, the horse is so far out of the barn that we are trying to prevent the illness from becoming a full blown epidemic, if not a plague.

Home prices are down 18% year over year in the top 20 cities in the country and foreclosures have increased by approximately 40%. Both of these figures are certainly headed further in those directions with continued losses for the holders of the underlying mortgages, whether those mortgages are already pooled into securities or held in whole loan form.

The unintended consequences of a principal reduction program will likely be an increase in mortgage rates over the longer term along with a more stringent credit review for those applying for a mortgage. Why will this happen? Very simply, investors in mortgage securities will demand those concessions if they are to purchase mortgages that have the chance of being “crammed down.” Additionally, this program may actually incentivize some borrowers to intentionally become delinquent in their mortgage payments, and actually risk personal bankruptcy in an attempt to be “crammed down.” Where does the madness end?

Read the rest »

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Why Is the Market Selling Off Today?

Posted by Larry Doyle on April 20th, 2009 2:30 PM |

The broad equity market indices are down 3+% on the day. Why would that happen when the bulk of company news today was generally positive? At least on the surface the news was positive:

1. Bank of America posted .44 earnings per share vs. expectations of .04
2. Eli Lilly earnings were up 23% outpacing expectations.
3. Halliburton disappointed with earnings down 35% but that is due to the massive correction in the price of oil from a year ago.
Merger Activity:
4. Oracle is purchasing Sun Microsystems in a $7.4 billion deal.
5. Pepsi is buying two bottling companies for $6 billion.
6. Glaxo is purchasing Stiefel for $2.9 billion.

Leading economic indicators declined by .3 but that decline is offset by an improved reading from the prior month.

Then, why is the market down so much? Two reasons are promoted, but only one of them is getting proper coverage.

Market analysts supposedly are focused today on the ongoing increases in chargeoffs and writedowns on the loan portfolios in the banking industry. These loans consist of credit card loans, residential mortgages, commercial mortgages, and corporate loans.

I don’t buy this line of reasoning for today’s selloff. Increased chargeoffs and writedowns have been widely expected for a while. The level of reserves taken by the banks has been widely panned as being insufficient. Then why is the market down so much? Read the rest »

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Repaying TARP Funds: Playing Ball With Uncle Sam

Posted by Larry Doyle on April 20th, 2009 10:27 AM |

Last evening on NQR’s Sense on Cents with LD (note: you can listen to audio recording of the show from the BlogTalkRadio player in the right sidebar), I proposed that the Obama administration would not release individual results of the Bank Stress Tests. I further added that I thought the administration may encourage stronger banking institutions to channel funds to weaker institutions. In so doing, these stronger banks – such as JP Morgan and Goldman Sachs – may actually take equity stakes in the weaker banks. Will JP Morgan and Goldman bear the entire risk of those equity stakes? Doubtful. Uncle Sam will likely negotiate terms along the lines of other bank bailouts in which a strong bank provides capital but the government bears the brunt of the losses.

As I write this, Bloomberg reports Bank of America is speculated to need another $10-20 billion in equity capital. BofA’s earnings were reported this morning at .44 earnings per share versus an expectation of approximately .03 earnings per share. Analysts are panning the earnings due to the propsects for ongoing increases in credit losses within BofA’s loan portfolio. BofA’s stock is down approximately 8% in early trading.

If BofA does need another $10-$20 billion in equity capital, where might it come from? In my opinion, in a non-public transferral of capital, those funds may come from JP Morgan and/or Goldman Sachs, and would actually be recycled TARP funds. Effectively, JPM and GS will merely be a conduit for increased government funds injected into BofA and Citigroup, as well. Remember JPM has $25 billion in TARP funds, Goldman has $10 billion. If BofA took $15 billion of these funds then Citi could receive $20 billion. What would JPM and GS receive in return? I would think these negotiations would be private and not released, although given that the capital provided is public money all information should be released. Read the rest »

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Is the Stimulus “Stimulating?”

Posted by Larry Doyle on April 20th, 2009 5:30 AM |

As I referenced on my radio show last evening (note: you can listen to an audio recording of the show from the BlogTalkRadio player in the right sidebar), China’s economy is benefitting from economic stimulus enacted by its government. Well, the U.S. government also enacted a major Stimulus Package in early February. How is our package doing? Is it impacting the economy? Our economy certainly does not seem to be benefitting significantly from any government stimulus.

I wrote on February 7th that Martin Feldstein, renowned Harvard economist who sits on Obama’s Economic Recovery Advisory Board, called the Stimulus Package An $800 Billion Mistake.

Feldstein’s concerns about the Stimulus as reported by the Washington Post, focused on several items:

1. On the spending side, the stimulus package is full of well-intended items that, unfortunately, are not likely to do much for employment.

2. The largest proposed outlays amount to just writing unrestricted checks to state governments.

3. The plan to finance health insurance premiums for the unemployed would actually increase unemployment by giving employers an incentive to lay off workers rather than pay health premiums during a time of weak demand.

4. A large fraction of the stimulus proposal is devoted to infrastructure projects that will spend out very slowly, not with the speed needed to help the economy in 2009 and 2010.

5. The problem with the current stimulus plan is not that it is too big but that it delivers too little extra employment and income for such a large fiscal deficit.

Let’s see how business executives view the rollout of the Stimulus Package. Would they agree or disagree with Feldstein’s concerns? Read the rest »

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I Need That Money More Than You Do

Posted by Larry Doyle on April 19th, 2009 9:15 PM |

Cartoon by Steve Kelley, The Times-Picayune

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Audio Recording of NQR’s Sense on Cents with Larry Doyle for April 19, 2009

Posted by Larry Doyle on April 19th, 2009 9:09 PM |

In case you missed LD’s Sunday night radio show, just click on the Play button below for the audio recording. Once the playback has started, you can fast forward or rewind to any portion of the show by clicking at any point along the play bar.

Larry’s special guest was Chris Lowney, author of Heroic Leadership: Best Practices from a 450-Year-Old Company that Changed the World

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Bank Stress Tests: Threading the Needle

Posted by Larry Doyle on April 19th, 2009 12:44 PM |

For those involved in assessing the solvency of our domestic banking system, the prospects of releasing the results of the Bank Stress Tests are frightening. How do Secretary Geithner, Fed chair Bernanke, regulators, and President Obama himself maintain credibility with the markets while simultaneously growing confidence in the public?

As Bloomberg reports, Bank Regulators Clash Over U.S. Stress-Tests Endgame. Secretary Geithner clearly was trying to buy time when he proposed the Bank Stress Test model. The day of reckoning will soon be upon us. The administration will release the model used on April 24 and the results on May 4th. However, there are enormous conflicts within the administration and the regulatory community as to how to release the information and how much information to release.

As Bloomberg highlights,

The U.S. Treasury and financial regulators are clashing with each other over how to disclose results from the stress tests of 19 U.S. banks, with some officials concerned at potential damage to weaker institutions.

With a May 4 deadline approaching, there is no set plan for how much information to release, how to categorize the results or who should make the announcements, people familiar with the matter said. While the Office of the Comptroller of the Currency and other regulators want few details about the assessments to be publicized, the Treasury is pushing for broader disclosure.

The disarray highlights what threatens to be a lose-lose situation for Treasury Secretary Timothy Geithner: If all the banks pass, the tests’ credibility will be questioned, and if some banks get failing grades and are forced to accept more government capital and oversight, they may be punished by investors and customers.

“There are plenty of ways to go wrong here,” said Wayne Abernathy, executive vice president of the American Bankers Association in Washington. “It might have sounded good at the time, but now looking back, it has far more risk than benefit.”

What will come of this? The pressure from all corners is increasing on Geithner. Can he snatch victory from what may appear to be a lose-lose situation? Can he somehow or other get the results forestalled and maintain credibility? Can he keep the various constituencies placated? Truly, he needs to “thread the needle.”

Listen to NQR’s Sense on Cents with Larry Doyle this evening from 8-9 p.m. as I discuss how I think Secretary Geithner will try to thread the needle.

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Tune in Sunday Evening to NoQuarter Radio’s Sense on Cents with Larry Doyle

Posted by Larry Doyle on April 19th, 2009 7:34 AM |

Please join me Sunday evening from 8-9 p.m. ET for NoQuarter Radio’s Sense on Cents with Larry Doyle. The developments in the markets, economy, global finance, Wall Street, and Washington are occurring at breakneck speed. I will try to slow things down a bit and provide a sense of perspective. What did we learn in the markets over the last week and what does that mean for the weeks and months ahead? We will address a wide range of issues, including: transparency and quality of earnings, Goldman’s and JP Morgan’s initiative to pay back TARP, and upcoming bank stress test results.

In addition, my guest Sunday night will be Chris Lowney. Lowney, formerly a Jesuit, was named a Managing Director of J.P. Morgan while still in his thirties and held senior positions in New York, Tokyo, Singapore and London until leaving the firm in 2001. He served successively on Morgan’s Asia-Pacific, Europe, and Investment Banking Management Committees. Lowney’s first book, Heroic Leadership: Best Practices from a 450-Year-Old Company that Changed the World, was the #1 ranked bestseller of the CBPA (Catholic Book Publishers Association) and was named a finalist for a 2003 Book of the Year Award from ForeWord magazine. It has been translated into ten languages. Read the rest »

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Don’t Try This at Home

Posted by Larry Doyle on April 18th, 2009 5:08 PM |

Have you ever watched a stuntman spin a sports car in a sharp 180 degree maneuver? Many stunts come with the advance warning: Don’t Try This at Home.

Not that the current actions of both the U.S. Treasury and Federal Reserve are stunts, but their maneuvers also come with a serious warning signal . . . and it reads: INFLATION!!

Given the doubling in size of the Fed’s balance sheet, if and when the economy catches, the multiplier effect on our domestic money supply will be akin to throwing lighter fluid and a match on a field full of hay. That inferno can create a scenario worse than our current economic predicament.

The WSJ reports:

“The key to preventing inflation will be reversing the programs, reducing reserves, and raising interest rates in a timely fashion,” he (Fed Vice Chairman Donald Kohn) said.

Reversing the programs? With all due respect, if people think the Fed or anybody else is uniquely qualified to drain trillions in liquidity from our markets in a precise manner prior to inflation running rampant, then they are sadly mistaken. Please remember that one of the biggest factors in determining the rate of inflation is the mere expectation of inflation itself. In so many words, our economy may start to experience inflation prior to changes in certain fundamentals in the economy.

While the WSJ reports, Fed’s No. 2 Allays Worries About Stimulus, please remember that any medication that is overused, if not unintentionally abused, can be very dangerous if not fatal. We need look no further than the use of CDS (credit default swaps). CDS used properly provide a valid means of hedging risk. Similarly, increasing the money supply via an increase in the use of the Fed’s balance sheet and assorted Treasury programs can be an appropriate medication.

However, have you ever heard a patient indicate an exact point in time when they knew they were using medication inappropriately, if not in an abusive fashion? Have you ever witnessed a patient who has misused medication to be able to turn his life around on a dime?

I appreciate Mr. Kohn’s confidence in the Fed’s abilities, but neither he nor the Fed have experience in dealing with a situation like this.

Don’t think for a second that the cure can’t be worse than the disease.

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Wall Street Buys Albany

Posted by Larry Doyle on April 18th, 2009 1:00 PM |

The “pay to play” game in which municipal, state, or federal officials solicit or accept kickbacks in turn for directing government business is regrettably deeply embedded into our political and financial industries. As much as authorities and regulators talk about cleaning it up, without aggressive deterrents in place to truly punish parties on both ends of a transaction, these corrupt activities will continue.

As we follow the money once again, we see that it leads to a firm named Quadrangle, recently headed by Steven Rattner, the current car czar. Associates at Quadrangle have been implicated in providing kickbacks to individuals who manage the allocation of funds from the New York State pension.

This scenario has all the sordid details of a B-rated movie or a tawdry teenage novel. While the characters involved may be cheap in terms of character and integrity, the cost borne by taxpayers and society is very dear. If one allocation of funds from the pension is polluted by kickbacks, it would be naive to think that many dollars emanating from the New York State pension is not similarly polluted.

Why is it that President Obama selected Steven Rattner for the high profile position of car czar? To be perfectly honest, I would imagine that Secretary Geithner and Larry Summers selected Rattner. Geithner and Summers know how to play the Wall Street game and have benefitted from it. Read the rest »

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