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HomeHow Will Banks ‘Manage’ Earnings?
Posted by Larry Doyle on July 14th, 2009 8:09 AM |
A number of major financial institutions are reporting 2nd quarter earnings this week. Actually, to say these institutions are truly reporting earnings would be a misnomer. To a large extent, these institutions are releasing managed earnings reports. What does that mean? Let’s navigate this ever important sector of our economic landscape.
In simplistic fashion, earnings are revenues less expenses. While financial analysts may want us to take reported earnings on face value, there is a lot more to it than that. What are the quality of the earnings? Are revenues increasing or decreasing? Are expenses increasing or decreasing? Are net margins of profitability increasing or decreasing? Are earnings a function of a growth in revenues or more a reduction in expenses?
In regard to a financial institution’s earnings, the greatest expense is typically compensation and benefits. On Wall Street, the expense associated with personnel usually runs between 50-55% of overall expenses.
On the revenue side of the ledger, earnings are broken down by division. How much revenue is produced from fee-generating business units and is repeatable versus how much is generated from volatile trading businesses and is thus more risky. Fee generating revenue is considered to be of higher quality. As such, the market attaches a higher multiple to the earnings from those business units.
In my opinion, the most opaque component of earnings and income statements revolves around valuations of assets held on the financial institution’s books. This component of an earnings statement is truly where the financial wizards on Wall Street get most creative. The assets to which I refer are:
1. Securities positions, that is, the variety of different bonds, stocks, and derivatives held by the institutions. While plenty of these assets are very liquid, easily evaluated, and thus easily marked, others are much less so. For a wealth of toxic assets (different types of mortgage assets, CDOs, and the like), these institutions were blessed by the FASB (Federal Accounting Standards Board) to mark them at levels which they deem appropriate versus where the assets may actually be trading in the marketplace. In the process, these institutions are sitting on hundreds of billions of embedded, yet unrealized, losses. How and when may those losses be recognized? When the underlying loans backing these securities default. Let’s move to that aspect of ‘managed earnings.’ (more…)
Interview on The Rude Awakening
104.3FM Tampa Bay
Posted by Larry Doyle on July 13th, 2009 9:27 PM |
I am returning for a second interview on The Rude Awakening 104.3FM Tampa Bay Tuesday morning July 14 at 8:15am.
I look forward to my discussion with hosts John Busacca and Rogan LaBier about the markets, economy, and financial regulation, specifically in regard to FINRA. Always a lively discussion.
Click on the “Listen live” tab at StreetBiz.com.
LD
VAT by Any Other Name Is a Tax Increase
Posted by Larry Doyle on July 13th, 2009 5:13 PM |
How does a politician pretend to keep a campaign pledge and simultaneously fund a ballooning deficit? Very skillfully. Do not be surprised to see some sleight of hand in the process. How does one define tax increase and on whom? Let’s play politics, Washington-style.
While Obama rode his promise of only increasing taxes for the top 5 % of wage earners in our country, no credible analyst currently believes that. Bloomberg’s Al Hunt opines, Obama Can’t Avoid Taxes in Fixing Fiscal Mess.
With our deficit soaring, tax revenues plummeting, and a whole set of new federal programs coming online, Obama and team have no choice but to craft new taxes. Hunt proposes:
While the majority of a deficit package will likely consist of enhanced revenue, that’s complicated by three painful realities: Some of the most palatable initiatives will be skimmed off by the costly health-care and climate change legislation; the president made a campaign commitment not to raise taxes on anyone making less than $250,000 a year, and huge amounts of money have to be raised.
Compared to boosting taxes directly on middle-income earners or slashing domestic programs, a value-added tax as a partial replacement for income and possibly some payroll taxes may be a more attractive alternative, Altman believes. A growing number of Democrats, such as Senate Budget Committee Chairman Kent Conrad and Obama tax-reform adviser Paul Volcker, concur.
If so, it will cause a political bloodbath, particularly if it is a big net revenue-raiser. The “sales tax” label can be lethal. Consumption levies are usually regressive, hurting middle class and poorer people the most, and almost three decades later there remains a belief that espousing such a measure cost the former House Ways and Means Committee Chairman Al Ullman, now deceased, his supposedly safe seat in 1980.
Raising taxes is often a death knell for a politician, so I find it very interesting that Altman, Conrad, and Volcker are looking for an approach to raising taxes which is politically expedient. Nothing better than proposing a tax which has not been previously used in the United States. The VAT, more commonly delineated as the value-added tax, is widely utilized in the European Union.
Make no mistake, though, the VAT is a form of a sales tax and ultimately gets passed along to the consumer. As such, it is typically considered a regressive tax, that is, a tax which more impacts the lower and middle incomes.
In true political fashion, our leaders are as much concerned with the delivery and appearance of these tax increases as they are the results. Hunt asserts:
Conrad believes that once politicians look at the challenge — deficits as far as the eye can see, insufficient savings, over-reliance on regressive payroll taxes — “a value-added tax in combination with a high-end income tax” will seem more acceptable than directly hitting middle-and upper-income taxpayers.
While politicians will not tell you taxes are going up, they are not being straightforward on this issue. No matter how you slice it, taxes are going up on everybody.
LD
“There Are No More Paper Clips to Cut”
Posted by Larry Doyle on July 13th, 2009 2:04 PM |
Can we afford public pension obligations?
If ever there were a political hot button, it is the issue of restructuring public pensions. I can hear the rumble rolling through cities and towns by my merely broaching this issue, but the fact of the matter is this topic must be addressed!
As with any debt, public pension obligations can either be paid in full or defaulted, devalued, or restructured. The public pension system in our cities, states, and towns is nothing more than the holy grail for a large swath of the electorate. Does the political power base in these districts have the courage to go down the restructuring road? In so doing, they potentially risk their own political lives given the strength of the electorate who are pension beneficiaries.
Why do I think restructuring pension obligations is a likely scenario? Very simply, there is only so far a mayor or governor can go with increased taxes and cuts in services. While I do not think restructuring pension obligations is an imminent development, I do think it will be part of the eventual reality of our new economy.
I see mounting evidence of this likelihood at a site I reference regularly, PensionWatch, which highlights:
That approaching wave of pension debt is bigger than it looks. The purpose of this site is to provide an overview of the multiple pension crises that are about to drown America’s taxpayers.
In my opinion, this story gets limited coverage because it touches the equivalent of the ‘third rail’ for politicians and their associates. Well, it is high time the population at large addresses these obligations. As USA Today writes, Our View on Retirement Benefits: Public-Employee Pensions Put Cities, States in Tight Squeeze:
Recent stock market declines have left public and private pension plans alike underfunded, but the problem is deeper for public plans because they offer bigger pensions and make them available earlier, particularly to public safety employees. Three-fifths of state-government pension funds owe at least 20% more money than they have. According to the National Association of State Retirement Administrators, the shortfall is $430 billion, or about $3,800 for every U.S. household. Other estimates put the number above $1 trillion. (LD’s emphasis)
The blame for this lies with vote-hungry politicians who promise rich retirement benefits from the wallets of future taxpayers.
Union inflexibility doesn’t help, either: In financially desperate Oakland, for example, where police starting salaries are $71,832 to $90,540 a year and pensions begin at age 50, the union rejects concessions.
Public-sector pensions already cost twice as much, per retiree, as the average private-sector pension, according to the U.S. Labor Department. This leaves cities and states no easy way out. They should not renege on their commitments, but the other options — raising taxes or cutting services — could prove so severe that bankruptcy would look like a sensible alternative.
I do not envision politicians willingly taking this issue on simply because the pension beneficiaries are typically their meal ticket to re-election. However, every once in a while we come across a politician who is willing to say he is not capable of “pulling the rabbit out of the hat.”
Scott Lang, mayor of the heavily Democratic city of New Bedford, MA, recently said as much. The Boston Globe reports Running on Empty:
Lang may be better remembered for his clarion call demanding structural changes in municipal government than for his performance in any specific area of city oversight. He is known for his candor, and he doesn’t disappoint.
“It’s absolute insanity. They’re unsustainable,’’ he says about pensions. “There isn’t the money to pay for an unfunded liability like that. All the revenues will be eaten up by past-due promises. Pensions have a 20-year schedule modeled after the industrial plan. It doesn’t fit today.’’
He says current pension and health insurance systems for city employees have to go, period. If not, they will destroy the city and its ability to maintain the services people expect like public safety. He calls for “pension relief’’ and “healthcare reform,’’ which in plain English means cuts.
“There are no more paper clips to cut.’’
To follow developing stories in the world of pensions, you can subscribe to PensionWatch from its home page, or even better you can access it here at Sense on Cents.
LD
Will Japan Take a Samurai to the U.S. Dollar?
Posted by Larry Doyle on July 13th, 2009 11:51 AM |
Is the economic influence of the BRIC nations (Brazil, Russia, India, and China) gaining momentum and a huge ally in the assault on the U.S. dollar? It would appear so. What country is also questioning the validity of the greenback as the international reserve currency? Our second largest creditor, that being Japan.
Bloomberg highlights, DPJ’s Nakagawa Says Japan Should Diversify Reserves:
Japan’s opposition party, leading in polls ahead of next month’s election, said the nation should consider shifting its $1 trillion of foreign reserves away from the dollar and buying International Monetary Fund bonds.
“In the medium to long term, we need to do what we can to avoid the risk of currency losses or economic turbulence that could result if the dollar were to swing,” Masaharu Nakagawa, the shadow finance minister in the Democratic Party of Japan, said in an interview in Tokyo on July 9. “Many countries are starting to diversify their reserves.”
When nations that are not exactly strong allies call for a change in the sovereignty of our U.S. dollar as the international reserve currency, that is one thing. When leaders of leading political parties within nations closely allied with the United States do the same, that is an entirely different issue.
Clearly, Nakagawa sees the shift in momentum away from the dollar and is looking to curry favor with the BRIC nations. However, make no mistake, current holders of U.S. dollars and dollar denominated assets face a real predicament if the dollar weakens. How do these nations diversify their holdings while protecting their existing dollar positions?
1. They would have to sell dollars or dollar denominated assets which would depress the value of their remaining positions. Not exactly an appealing proposition.
2. They would have to stop purchasing or significantly cut back their purchases of dollars and dollar denominated assets. This maneuver would also depress the value of their positions and is also unappealing.
Is there a third means for these nations to gain diversity? It would not necessarily seem so. However, Japan’s Nakagawa believes there is another means. Bloomberg highlights:
Nakagawa, 59, said Japan’s government should ask the U.S. to sell debt denominated in yen, so-called samurai bonds, as a way to diversify reserves and promote the globalization of the yen.
Wow!! Are we turning Japanese? (more…)
Education is Everything
Posted by Larry Doyle on July 13th, 2009 8:15 AM |
Has there ever been a time when increased skills and education have not been vitally important to furthering one’s well being? As we move forward in developing our ‘new’ economy, education and advanced skills will be increasingly more important.
I would only wish that the dirty little secrets embedded in urban education were more widely disseminated so that ‘real’ progress can be made. I see evidence of these secrets again this morning in reading the New York Times. The lead article in the right hand column of the front page highlights, Black-White Gap in Jobless Rate Widens in City:
Unemployment among blacks in New York City has increased much faster than for whites, and the gap appears to be widening at an accelerating pace, new studies of jobless data have found.
While unemployment rose steadily for white New Yorkers from the first quarter of 2008 through the first three months of this year, the number of unemployed blacks in the city rose four times as fast, according to a report to be released on Monday by the city comptroller’s office. By the end of March, there were about 80,000 more unemployed blacks than whites, according to the report, even though there are roughly 1.5 million more whites than blacks here.
Across the nation, the surge in unemployment has cut across all demographic lines, and the gap between blacks and whites has risen, but at a much slower rate than in New York.
Economists said they were not certain why so many more blacks were losing their jobs in New York...(LD’s highlight)
What? Not certain? Once again, economists and public policy analysts are not being honest on the disastrous state of urban education. I highlighted this point the other day in my call for total transparency and honesty on this topic. In writing Warren Buffett: “Wall Street Owes the American People”, I called for:
1. honesty on where we currently stand across all aspects of our economy and society. Publicize our successes and, more importantly, our failures so we can properly address them.
Do not allow urban education dropout rates of 50% to be swept under the rug. Promote the correlation between those figures, single parent birth rates, income levels, and criminal behaviors. BE HONEST ON THESE TOPICS!!!
While economists and the New York Times itself may not want to publicize education statistics, the fact is New York City’s public schools, like most major urban schools, are disproportionately filled with minority students.
For New York City, that breakdown is: (more…)
A Sunday Morning Review
Posted by Larry Doyle on July 12th, 2009 7:36 AM |
I always enjoy reading the thoughts and opinions of John Mauldin, an economic All-Star here at Sense on Cents. Mauldin himself provides insightful perspectives, but he has a number of relationships who weigh in with probing analysis from around the globe.
Mauldin’s recent ‘Outside the Box’ article, “A Tale of Two Depressions,” provides a wealth of information and analysis on the global economy. I personally found this piece beneficial in juxtaposition to yesterday’s Recommended Weekend Reading, “Aftermath of Financial Crises” by Carmen Reinhart and Kenneth Rogoff.
I feel strongly that we need to focus on the current not the waves, the forest not the trees. On that note, I hope you find this commentary and all other work here at Sense on Cents to be helpful as you navigate the economic landscape!
Please join me this evening at 8PM to address these topics and others on my Sunday night radio show, NoQuarter Radio’s Sense on Cents with Larry Doyle.
LD
NoQuarter Radio’s Sense on Cents with Larry Doyle
Sunday Evening at 8PM
Posted by Larry Doyle on July 12th, 2009 7:30 AM |
UPDATE: The show has concluded, but you can listen to a recording in its entirety by clicking the Play button on the audio player below. 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.
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Slow summer doldrums in the markets, economy, and geopolitical spheres? Anything but!! While many in the media and markets would have us believe we are close to turning the corner, the simple fact is we are playing a new game on a new landscape.
The developments within our economy will be both dynamic and painstaking. Don’t despair. Those who are able to grasp the new economy will thrive.
To that end, please join me tonight at 8PM and share with all of us your thoughts and opinions on the changing economic landscape. Let’s be the ‘pitcher,’ not the ‘catcher,’ as we navigate and blaze new trails in our new economy.
LD
Economic and Market Commentary July 14, 2009
Posted by Larry Doyle on July 14th, 2009 11:47 AM |
We have had a cross current of market moving news and developments this morning. Let’s navigate while bringing our own independent set of tools to cut through any excessive salesmanship or pandering on the part of market experts. Using Bloomberg as a conduit, they report Treasuries Fall as Rally in Global Stocks Damp Demand:
Bloomberg is better than this reporting. The reporters should more specifically highlight that across virtually every sector aside from gasoline and autos, retail sales declined. A rise in gasoline sales is simply a function of higher gasoline costs. That bit of news is not exactly a positive. Automobile sales are a long way from robust and are measured against prior month’s sales which had plunged.
I am not trying to be overly pessimistic, but merely looking for a full and honest analysis of the data. Moving right along, I strongly believe that Treasury rates increased (and thus Treasury prices declined) because of concerns about rising producer prices. As Bloomberg reports:
I also believe Treasury rates increased today on news that our annual federal deficit just crossed the $1 TRILLION level and is likely headed toward $2.0 TRILLION. No surprise why Secretary Geithner is in the Middle East for what amounts to a Wall Street roadshow in hopes that some of our largest creditors continue to finance our country.
On the earnings front, Bloomberg offers:
With all due respect to Mr. Di Galoma, America cares MUCH more about earnings in the heartland than merely the casino-style earnings generated by the inhabitants of 85 Broad Street in lower Manahttan, that being the home of Goldman Sachs. Earnings from Johnson and Johnson, CSX, Dell, Philips, Heartland, and Posco are decidedly mixed, and honestly generally weak.
Against those numbers, the fact that the equity market is merely unchanged on the day is a good performance.
In regard to upcoming earnings reports from our financial firms, please refer to my report this morning “How Will Banks ‘Manage’ Earnings?”
Bloomberg offers:
Put that $1.47 trillion figure in the context that the IMF projects TOTAL writedowns and credit losses at banks will be $4 trillion with $2.8 trillion of those here in the United States. To date, our banks have not taken half those writedowns and losses.
What do I see looking through all of this data and material? An increasing likelihood of a very sluggish economy with a whiff of inflation, otherwise known as stagflation!!
Remain defensive.
LD
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