The Mortgage Bankers Association is reporting that nearly one in ten households with mortgages are at least one payment behind.  That is a record, my friends. And it certainly means we cannot believe house prices have permanently stabilized.

The New York Times says:

The delinquency figure, and a corresponding rise in the number of those losing their homes to foreclosure, was expected to be bad. Nevertheless, the figures underlined the level of stress on a large segment of the country, a situation that could snuff out the modest recovery in home prices over the last few months and impede any economic rebound.

Unless foreclosure modification efforts begin succeeding on a permanent basis — which many analysts say they think is unlikely — millions more foreclosed homes will come to market.

Translation: there are a lot writedowns in residential real estate still coming. This is one reason bank credit is not going up significantly despite zero interest rates. Remember when I wrote about “extend and pretend?” This is the kind of thing that is holding up bank balance sheets. The article I wrote in October on short sales in North County San Diego highlights the issues involved. But at some point banks will have to take the hit (unless house prices magically go up to near previous levels – what everyone except renters wants).

Ivy Zelman has the same sinking feeling I do here; we don’t think house prices are necessarily heading up permanently. She even throws in a mixed metaphor to get her point across. She says:

I’ve been pretty bearish on this big ugly pig stuck in the python and this cements my view that home prices are going back down.

Look, the fake recovery is now in full swing.  But I expect the recovery to hit a brick wall by 2011, if not earlier. While the proximate cause of my concern is the likelihood of increased taxes and/or reduced spending by the Obama Administration, it is jobs that concern me. See Calculated Risk’s post showing the correlation between unemployment and mortgage delinquency and you see the connection. The fact is we have a record number of foreclosures and that is a direct result of rising unemployment. Unemployed people don’t have any money, so they don’t pay mortgages. It’s as simple as that.

The interesting bit about the New York Times article was this:

The number of loans insured by the Federal Housing Administration that are at least one month past due rose to 14.4 percent in the third quarter, from 12.9 percent last year. An additional 3.3 percent of F.H.A. loans are in foreclosure.

The fact is the F.H.A is the next Fannie Mae. If you’re looking and wondering where the next bailout will be, take a good look at the F.H.A. Not only is this agency guaranteeing hugely delinquent loans, but the Economic Stimulus Act of 2008 doubled the maximum loan that it could insure to $729,750 in order to cover jumbo mortgages common in cities like New York, San Francisco or D.C.. The purpose was to give liquidity to the frozen jumbo market in high-cost cities.  However, the net effect is that the F.H.A was expanding at exactly the time when loan quality was falling. There will be significantly more losses as delinquencies mount.

To make matters worse, the F.H.A. has an abysmally low 0.53% insurance reserve ratio – that’s the lowest ever. Yes, this ratio includes expected future losses, but you don’t have to be a rocket scientist to know any downside wipes these guys out. And that means more taxpayer money will be forthcoming.

Is this a pretty picture? No. But, is this what is going to happen? Of course it is.  So when the bailouts come because the foreclosures begin again in earnest and politicians start saying, “who could have known?” you will have every right to be disgusted.

Related posts:

• UK home prices fall in June
• A Home Price Firewall
• Can I borrow the full amount and an extra 25% too?
• Foreclosures hit a record in April
• Extend and pretend and the growing divide between delinquencies and foreclosures

I have written extensively about how I believe the bank bailouts were the worst of all possible solutions – fixes that perpetuate too big to fail, moral hazard and crony capitalism.  That ship has sailed, but the questions still linger – in large part because the fix has not trickled down to common folk to better their lot.  Rising unemployment is but one demonstration of this.

Arnold Kling writes a post that goes beyond banking to AIG, mortgages and Fannie and Freddie. He offers real world solutions that don’t require creating special resolution authority, buying toxic assets or orchestrating bailouts.  While there would certainly be costs to these solutions as well, they would be far less than what we are paying now.

The interesting bit is he proposed them in the moment when the bailouts were ongoing. Don’t let anyone tell you that there weren’t other options available because there were in spades.

1. Existing Mortgages and home owners.

Actual policy: attempts to implement loan modification programs

My policy: pay the moving expenses of homeowners who default on their mortgages. But do not interfere with the foreclosure process.

2. Mortgage Markets

Actual policy: keep Freddie Mac and Fannie Mae going, and we now have 90 percent of mortgage loans made by federal agencies.

My policy: Limit Freddie Mac and Fannie Mae to their existing book of mortgage loans (I wrote this in September of 2008) and not allow them to purchase any new mortgages. Let banks take up the slack in mortgage lending.

3. AIG

Actual policy: creditors bailed out 100 percent.

My policy: Send in a "stern sheriff" to protect the liquid assets of AIG from creditors making "collateral calls." I was thinking of a government-suggested mediator, perhaps a former bankruptcy judge. If the parties did not like it, they could go to court. But my guess is that the parties would have preferred a mediated solution.

4. Big banks

Actual policy: bailouts of nearly all of them

My policy: Triage. Shut down the ones that have clearly failed, using FDIC procedures. Those that are clearly solvent should be allowed to proceed. Those that are neither clearly failed nor clearly solvent should be given forbearance, but with tight supervision to ensure that they do not use this forbearance to expand their risk-taking. Again, this was what I advocated in September of 2008.

Why proposals of this sort were not followed is the subject of much debate.

Source

Was TARP Necessary? – Arnold Kling

Related posts:

• Fannie, Freddie to get $15 Billion from U.S. government
• Federal takeover of GSEs now in the works
• A quick note on corporate bankruptcy and bailouts
• Treasury to Consider Further Measures to Halt Housing Slide
• Dean Baker: I saw this scenario in 2002

There are a lot of threads to tie together in today’s reporting of news in the auto sector.

General Motors has reported a third-quarter loss of $1.15 billion. But all indications are that car sales continue to outpace expectations in the United States.  Meanwhile, there are conflicting stories that GM both plans to pay back its bailout money, and to use it to help its ailing European operations. I will try to tie all these stories into a common thread.

First are the earnings. This is the first report by General Motors since leaving bankruptcy.  The results are decidedly mixed showing increasing sales, but a large loss and declining liquidity.

The video above points to losses and negative cash flow. But Bloomberg has reported that GM had significantly positive cash flow in Q3: $3.3 billion worth. Irrespective, sales are up.

The New York Times’ Deal Book says:

Excluding taxes and one-time items like the costs related to restructuring its dealership network, G.M. said its operations lost $261 million from July 10 and September 30. The loss in North America was $651 million.

For the entire third quarter, including the final 10 days of G.M.’s bankruptcy, the company said its revenue was $28 billion, up 21 percent from the second quarter.

In addition, retail sales have revealed that car sales in the U.S. are still relatively brisk for October despite the expiration of cash for clunkers. So, GM is benefitting from more sales, but is still not making money and still seeing cash go out the door. Obviously, they are going to need to cut costs even more, unless they count on sales returning to pre-crisis levels.  However, all indications are that they do, as CEO Fritz Henderson says revenue growth is their number one priority.

“We have significantly more work to do, but today’s results provide evidence of the solid foundation we’re building for the new G.M.,” the chief executive, Fritz Henderson, said in a statement. “With a healthier balance sheet and a competitive cost structure, our focus is on driving top line performance.”

See the Bloomberg video below for my comments by Henderson.

Meanwhile, in what should be seen as a PR move, General Motors has also announced it will begin repaying government money. The first $1 billion to be repaid in December. The company will make $1 billion payments to the U.S. government and $200 million payments to the Canadian government every quarter. It has said it could repay all the aid money by 2011, four years ahead of schedule. Presumably, this does not include the equity government stakes which can be sold on in the open market in an I.P.O.

Given the fact that General Motors is still losing money, it would make sense for them to delay repayment. However, I reckon they are going to repay early in order to tamp down criticism about their government-funded bailout.

The same is true in Germany as well as GM has also announced it will repay ALL German state aid before month’s close.  That is big. It significantly reduces the German government’s leverage over GM plans for restructuring in Germany.

This makes the recent statements about using bailout funds to bolster European operations seem inexplicable. If GM is losing money and needs to use bailout funds to plug up holes in Europe because it has decided to renege on an agreement to sell operations, why is it paying back bailout funds?  Is it not obvious the company needs the money?

My interpretation of GM’s actions is this: they are still a loss-making company and their cost basis is unprofitable at present sales levels. In order to return to profitability, they will need to further reduce costs or increase sales. At present, management have opted to grow the top line – and this makes retaining the European operations vital as the auto technology at Opel is considered first class.

So, GM has reneged on the Opel sale, risking the political backlash, because it is flush with bailout cash.  However, it knows that its desire to use these funds to stabilize the European business is likely to invite populist outcries in North America. This is why they have announced the repayment schedule today; it is purely a public relations maneuver to quell any anti-bailout sentiment. They are repaying German state aid for similar reasons, but also because it gives them greater flexibility in making operating decisions about job cuts and plant closures.

As GM is not publicly traded, we do not have stock prices as a gauge of how receptive investors are to these latest moves. But, according to Bloomberg, GM 8 3/8 bonds maturing 2033 jumped significantly, adding $2.63 to move to $20.3 on $100 par value.

You can expect to see GM as a topic in both the business and political press for some time to come.

Related posts:

• GM looks to use US and Canadian tax money to bailout Opel
• GM and Chrysler to get more bailout money
• GM headed for bankruptcy
• GM considers keeping Opel, raising capital
• Chrysler: bulls make money, bears make money, pigs get slaughtered

An article in the National Post suggests General Motors may look to divert some of its bailout money to Europe in the wake of a chill in German government support for subsidies. Talk of using taxpayer money to benefit workers in other countries is sure to raise ire, especially in the United States where the unemployment rate has hit double-digit levels.

When General Motors was forced into receivership this past Spring, it received tens of billions in bailout money from the U.S. and Canadian governments in order to protect jobs in the auto sector.

For his part, Stephen Harper, Canada’s Prime Minister said the aid was regrettable but necessary.

The Vancouver Sun reported at the time:

Canada had no choice but to support the restructuring of auto giant General Motors Corp. with about $10 billion in taxpayer aid or face devastating economic consequences, Canadian government and union leaders said Monday.

Hundreds of thousands of jobs would have been lost and communities across southern Ontario would otherwise have been devastated, Prime Minister Stephen Harper and Ontario Premier Dalton McGuinty said at a news conference Monday, hours after the 100-year-old company sought protection from bankruptcy in the U.S.

"We could either participate in reshaping these companies for the future or stand idly by as they restructured out of Canada," Harper said in Toronto.

"The decision announced today is regrettable but necessary."

The federal and Ontario governments’ contribution to the restructuring is set at $9.5 billion US, according to a joint statement Monday from the prime minister and U.S. President Barack Obama.

For that, Canadian taxpayers will hold a 12-per-cent equity stake and will also appoint one independent director to the company’s board.

The U.S. government sunk even more into General Motors – $50 billion. All of this money and the ‘cash for clunkers’ program have allowed General Motors to return to life. However, many issues remain, the most consequential of which is GM Europe. 

Since late May, it has appeared that a consortium headed by Magna International was set to take over GM Europe on the condition of 4.5 billion in state aid from Germany. As early as August, stories surfaced in which GM was considering raising capital in order to keep Opel. GM never wanted to sell Opel and Vauxhall, but it was forced to do so by circumstance.

However, when GM abruptly backed out of the Magna deal early in November it enraged the German government, who are now not likely to offer any aid. At the time I said:

Will Obama now come up with the funds?  If this minister gets his way, there don’t seem to be a whole lot of solutions here.

Well, here is one solution via the National Post (note the part I have highlighted in bold):

General Motors Co. may use some of the money it won from Canadian and U.S. taxpayers in the spring to fix its Opel unit in Europe in the months ahead as it works out a new financing plan for the money-losing business.

Detroit-based GM plans to fund Opel’s turnaround using a mix of sources after deciding to keep the business itself instead of selling a majority stake to Magna International Inc. and Russia’s Sberbank. That could include tapping funds pledged by the federal and Ontario governments, said Chris Preuss, GM’s vice-president of global communications.

"We’re going to be needing to participate directly in the financing" of Opel, Mr. Preuss said in an interview yesterday. "The taxpayers of both Canada and the U.S. have a stake in this. But what was agreed upon was that we have to be able to run a global business."

Translation: GM has every right to use its bailout money as it sees fit.

GM continues to misjudge the political situation. They handled the decision to back out of the deal with Magna very poorly. We are now likely to see increasing signs of economic nationalism at play.

But, just as the backing out created huge waves in Germany, this latest salvo from GM is likely to enrage Canadians and Americans as they see their tax dollars at work to protect the jobs of Europeans. GM may think using Canadian and American bailout funds for GM Europe is a good ‘technical’ solution. But, it is a very poor choice politically and they will pay the price.

Related posts:

• Germany gives GM a stiff arm on state aid
• Germans reject Chinese offer for Opel
• GM considers keeping Opel, raising capital
• German Press: Fiat to sign a deal with Opel, not Chrysler
• GM board decides to keep European Opel unit

The Jamie Dimon piece in today’s Washington Post is a must-read. Dimon, head of behemoth JPMorgan Chase makes the best case for not breaking up large too-big-to-fail financial institutions. His idea: set up a robust resolution process and let reckless lenders fail regardless of size.

Now, back in September, I attended a meeting at the Clinton Global Initiative where both Americans Sheila Bair and Jamie Dimon and British bank executive Peter Sands gave their ideas on the too big to fail idea. They all agreed that too big to fail must end. But, while Bair was arguing for shifting the balance of power toward smaller, community banks, Dimon was arguing, as he does in the Post, to keep large organizations intact.

Reviewing the exchanges, I wrote:

What I found interesting was the general agreement between Dimon, Sands and Bair that regulatory reform to date has been a bust…  the conversation made clear that Bair, Dimon and Sands all felt that the first and most important bit of financial reform must be to set up a resolution process in order to deal with too-big-to-fail institutions. Let me characterize Dimon and Bair’s remarks below.

Jamie Dimon. It is clear that Dimon believes JPMorgan Chase was never in any real jeopardy during the financial crisis. He spoke on several occasions about the lack of a resolution crisis to deal with large firms without mentioning any names, but clearly intimating that other beleaguered institutions like Citi and BofA were saved by this. He said that the financial crisis should not be used as an excuse to break up large institutions (like his) because the crisis was the result of bad lending as in any other crisis. He said, smaller imprudent lenders are being liquidated systematically by the FDIC. The only reason larger companies did not face liquidation is because no resolution mechanism was or still is in place to deal with them…

He said the present reform proposals are not heading in the right direction and used an analogy saying, “If we had a problem with our legal department, I would tell the guys to fix the legal department. If the government had the same problem, it would create a second new legal department.”  Over-regulation is not the answer. Smart regulation is.

Sheila Bair. Bair was in stunning agreement with Dimon on the core issues. She too said the first priority of any financial regulation must be to put a resolution mechanism in place to deal with too-big-to-fail institutions. She rejected the concept of the Federal Reserve as the main financial regulator, something even Ben Bernanke is now rejecting. But, she disagreed with Dimon. Instead she felt that the financial system had veered excessively into derivatives and other complicated financial products and that this was a major contributor to the financial collapse. She advocated regulating these and increasing the focus on traditional banking products typical in community banking. It was clear from these remarks that she favors community banks over too-big-to-fail institutions.

Both points of view make sense. Dimon is obviously advocating from the position of an interested party. Nevertheless, he does make good arguments. Note that he says management should be fired. Shareholders should be wiped out. Unsecured creditors should, if necessary, be wiped out too. This is a big deal.

Here are excerpts of what he had to say (bolding added).  The link to the full article is at the bottom.

Our company, J.P. Morgan Chase, employs more than 220,000 people, serves well over 100 million customers, lends hundreds of millions of dollars each day and has operations in nearly 100 countries. And if some unforeseen circumstance should put this firm at risk of collapse, I believe we should be allowed to fail…

But ending the era of "too big to fail" does not mean that we must somehow cap the size of financial-services firms. Scale can create value for shareholders; for consumers, who are beneficiaries of better products, delivered more quickly and at less cost; for the businesses that are our customers; and for the economy as a whole. Artificially limiting the size of an institution, regardless of the business implications, does not make sense…

Creating the structures to allow for the orderly failure of a large financial institution starts with giving regulators the authority to facilitate failures when they occur. Under such a system, a failed bank’s shareholders should lose their value; unsecured creditors should be at risk and, if necessary, wiped out. A regulator should be able to terminate management and boards and liquidate assets… We can learn here from how the Federal Deposit Insurance Corp. closes banks…

…It also requires effective international cooperation, as the implications of a major financial institution’s failure are global. This is challenging but worth doing…

As we have seen clearly over the last several years, financial institutions, including those not considered "too big," can pose serious risks for our markets because of their interconnectivity. A cap on the size of an institution will not prevent that risk. Properly structured resolution authority, however, can help halt the spread of one company’s failure to another and to the broader economy…

To understand the harm of artificially capping the size of financial institutions, consider that some of America’s largest companies, which employ millions of Americans, operate around the world. These global enterprises need financial-services partners in China, India, Brazil, South Africa and Russia…

…a fragmented banking system cannot always provide the level of service, breadth of products and speed of execution that clients often need. Capping the size of American banks won’t eliminate the needs of big businesses; it will force them to turn to foreign banks that won’t face the same restrictions.

Source

No more ‘too big to fail’ – Jamie Dimon, Washington Post

Disclosure: I have no financial interest in any financial services companies. Further, I have said previously that I do not favor re-imposing Glass-Steagall as a magic bullet solution given that most financial carnage over the past twenty-five years has originated in the regulated commercial bank sector. Like Dimon and Bair, I see a robust regulatory regime as critical. On the other hand, I am generally in favor of reducing bank size, unlike Dimon.

Related posts:

• The failure to address the looming too-big-to-fail issue
• Jamie Dimon on the economy
• Jamie Dimon: ‘we don’t need’ your money
• Quote of the day: “Jamie is always hanging around the hoop”
• Jamie Dimon: “If You Are Not Fearful, You Are Crazy”

In a recent post, “How is Citi going to deal with $38 billion in deferred tax assets?,” I pointed to a Reuters article which called into question Citigroup’s ability to earn enough money to prevent its having to take a charge for an incredibly large deferred tax asset. That post generated a response from a Citi representative who emphatically defended Citi’s capital position with a chart comparing Citigroup to other large global financial institutions.

Below is that chart:

As you can see from the chart, based on Citi’s reported public accounts, the company is well-capitalized. Moreover, even hedge fund operators like John Paulson who maid a mint on shorting financials in 2007 and 2008 now think Citi is in much better condition. Paulson was known to be buying shares in August.

You could agree or disagree with Paulson about whether Citigroup is a buy at its present share price. And you could argue that Citi should be taking the charge that Willens suggests. But the fact is, Citi has been recapitalized – at taxpayer expense. And that’s more the point here. 

Citigroup has received more money from the government ($45 billion) than any other bank in the U.S., none of which has been paid back. Moreover, the government was forced to not just forgo dividends on its preferreds but also convert these into common equity and provide debt guarantees for the company. Absent government money, Citigroup is the worst capitalized big bank. Absent government money, Citigroup would not exist.

Even still, Citigroup cannot be nearly as profitable as it once was because it has been forced to sell assets in order to achieve its ratios. Yet, it is an organization with almost $1.9 trillion in assets and is certainly still too big to fail.

I see Citigroup as emblematic of the problems we face in dealing with large systemically dangerous institutions. They insist that we return to some semblance of business as usual after they have received massive bailouts without any clear timeline when those monies will be repaid – if ever. Meanwhile, it is far from clear what these institutions would look like if the collateral they put up for loans received from the Federal Reserve and the rest of their assets were marked to market.

I, for one, think the big banks have made it. I said so as far back as April. I may not like the way they have been recapitalized, but I am in little doubt that they have been.

But Citigroup and Bank of America in particular have gotten there with great help from taxpayers. All of the too-big-to-fail financial behemoths exist because of government largesse. That high-level executives of these organizations show little contrition or remorse for having cost our economy tremendously is the saddest part of this crisis.

Disclosure: I have no financial positions in Citigroup or any other financial services company.

Related posts:

• My take on the latest Citigroup bailout
• The Citigroup Bailout: a blogosphere post-mortem
• Rubin resigns from Citigroup
• Credit Suisse cautious on Citigroup due to regulatory hurdles
• Citigroup and Redecard: shedding international assets

You could see this one coming given the humiliating circumstances under which the German Chancellor learned that GM was pulling out of the Magna deal.

The BBC is now reporting that Germany will give General Motors no aid to restructure it’s business. That’s 4.5 Billion Euros they now need to come up with.

Economy Minister Rainer Bruederle told GM executives that they had to be responsible for restructuring the unit.

Germany had previously offered 4.5bn euros ($6.7bn; £4.1bn) to support Opel and protect German jobs if the company was sold to car parts maker Magna.

On cancelling the sale last week, GM said it would still seek state aid.

The German minister’s comments now raise question marks over whether GM will get it.

"I expressed my expectation that General Motors should basically carry out the financing itself," Mr Bruederle said.

Will Obama now come up with the funds?  If this minister gets his way, there don’t seem to be a whole lot of solutions here.

Related posts:

• Germans reject Chinese offer for Opel
• GM looks to use US and Canadian tax money to bailout Opel
• GM considers keeping Opel, raising capital
• German Press: Fiat to sign a deal with Opel, not Chrysler
• Economic nationalism and GM’s decision to keep Opel and Vauxhall

Fitch, the credit rating agency, has just downgraded the sovereign debt ratings for the Republic of Ireland from AA+ to AA-.  That is two notches and is proof-positive that the ratings agencies are worried about the hole in Dublin’s finances.

If you read the Irish press this morning, it is all doom and gloom and has a lot to do with the banks and budget deficit.  It is not just about the ratings downgrades.

The EU has just released figures putting in doubt Ireland’s rosy scenario for cutting budget deficits.

The Irish Independent says:

Next month’s Budget may set the economy back further, but without it the country’s national debt could reach 100pc of output (GDP) by 2011, the EU Commission has said in a new analysis.

The Commission is forecasting a decline of 1.4pc in Irish GDP next year. But Brussels is not taking the impact of next month’s Budget into account, because the details are not yet known.

"Depending on the specific measures that are eventually implemented, a dampening effect on consumer demand cannot be excluded," the Commission says in its autumn economic forecast.

Correction

On the other hand, it says that faster correction of the economy’s problems might give more support to consumption and investment by helping confidence.

The Government’s plans include a correction of 4.3pc of GDP — around €8bn — in the Budgets for 2010 and 2011.

Unless there is a compensating boost from confidence, this could also reduce the modest 2.6pc growth forecast for 2011.

These forecasts are higher than those in the Commission’s estimates last May, but it warns of the struggle facing the Irish economy in trying to return to strong growth.

Another top headline in the Irish Independent has the OECD warning that the Irish government should not rule out nationalising banks in addition to its bad bank programme, NAMA.

The Government shouldn’t rule out temporarily nationalising the country’s banks as they may require more capital to cushion against surging bad debts, the Organisation for Economic Cooperation and Development said.

The Government is setting up the so-called bad bank that will buy €77bn of property loans from banks at a discount of 30pc. Losses on those assets may leave the lenders needing extra capital.

“Further recapitalisation may be necessary as assets are being purchased below book value,” the Paris-based OECD said in a report today. “Temporary nationalisation would have a number of drawbacks, but it should not be ruled out altogether.”

The Government has already guaranteed all deposits at banks and some of their debts, pumped €7bn into Allied Irish Banks and Bank of Ireland and seized Anglo Irish Bank.

“Substantial” banking losses are likely to be met by the taxpayer and nationalisation should only be undertaken with the “utmost reluctance,” the OECD said.

The FT’s Stacy-Marie Ishmael has a piece out doubting the maths used in NAMA, which bolsters the OECD view that the bad bank may not be enough.

So you have a trifecta of bad news coming out of Ireland: a two-notch downgrade by a major ratings agency, a warning from the EU that the economy will be weak for sometime to come and that deficits targets will not be met, and another warning from the OECD that the banking situation in Ireland is still very grave.

Quite frankly, it is not looking good for an Irish recovery at this time without the help of the IMF. This all brings me back to my question one year ago: Is Ireland the next Iceland? They will be if the EU, IMF and Irish government do not take today’s bad news seriously and take drastic action to bolster the Irish banks, economy, and government finances.

Who said the financial crisis was over? It is not.

Related posts:

• Ireland: Next stop – IMF
• Ireland guarantees bank deposits at six banks
• Irish government unveils plan to recapitalise banks
• Ireland nationalizes Anglo Irish bank
• Is Ireland the next Iceland?

I am listening to Treasury Secretary Tim Geithner answer questions before the House Financial Services Committee and he seems to be talking the talk, but his Administration is not walking the walk. 

The bill he is aggressively defending calls for putting a resolution process in place which ostensibly allows the cost of the failure of a too big to fail to not be passed on to taxpayers or the wider economy.  The sentiments he expresses are the right ones. But, he is rightly being questioned about whether this proposal gives the executive branch power which it could abuse.

Meanwhile, just in the last 24 hours we learned that GMAC was effectively nationalized and non-government equity was inexplicably not wiped out.  The testimony and the actions are in direct contradiction with one another.

Congress is fully aware of this dichotomy. They seem to have a bit of bailout fatigue. That makes them mistrustful of Geithner’s intentions. As a result, he is facing some tough questions from Democrats and Republicans alike.

Related posts:

• Rosner: Financial Stability Act “single worst not-yet passed piece of legislation”
• Chanos: I warned Brown and Geithner of financial calamity
• Weekend Video: A Conversation with Tim Geithner at CFR
• My initial reactions to President Obama’s financial regulation proposal
• Is Bernanke Toast? If he is, Summers is a shoo-in

And you thought the bailouts were over and market discipline might be restored.  Not a chance – the bailouts will continue, come hell or high water. The latest demonstration of this is GMAC, where the government will now be majority owner. GMAC has officially been nationalized. Now the government is running auto financing in addition to running the companies making the cars.

Below is a quote from the Financial Times. Notice the parts I have bolded.

GMAC, the car financing company, is set to receive up to $5.6bn in a new capital injection from the Treasury, filling a hole identified in the “stress tests” earlier this year and paving the way for the government to become the majority shareholder.

The company, formerly the financing arm of General Motors, was one of 19 institutions to submit to a capital adequacy programme led by the Federal Reserve and completed in May. That determined that GMAC had a shortfall, which will now be provided by the government in the form of preferred equity, according to two people familiar with the situation.

As widely expected, GMAC has been unable to raise the necessary capital in the market and the company – which will take on fresh lending responsibilities when it merges with Chrysler Financial – was seen as vital to the government-led restructuring of the US automotive industry and deserving of more funds from the $700bn troubled asset relief programme.

“When we laid out the stress tests, we expressly said that some additional Tarp capital may be needed given the severity of the downturn – this capital need is not new information,” said an administration official.

“But the transparency brought about by the stress tests allowed all other institutions to raise the capital required by the stress tests to ensure these firms could withstand a more severe economic scenario than anticipated,” the official said.

What you should be reading from this statement is the following:

• All the firms identified as lacking capital under the stress tests were given time to raise funds in the capital market to meet the shortfall.
• Some firms did meet the shortfall and they are now free to do as they please.
• Others have not and we the government are now going to take a more muscular approach in dealing with them.
• GMAC is the first public example of our flexing our muscles.
• But there surely are/will be other examples; some may already be happening in secret.

If the US government is going to throw its weight around to deal with financial firms short of capital, I would personally prefer they try a process which allows these firms to fail whereby equity and debt holders suffer consequences that are consistent with taking market risk.  Bailing out GMAC is a moral hazard plain and simple.

But, what’s done is done. The GMAC case does, however, give a lot more credence to my view that Citigroup’s actions are being dictated by government. As I indicated when the stress tests were done in April, firms were going to get some time to raise capital and if they didn’t, the government was going to move on to Plan B (debt-for-equity swaps, nationalization, and FDIC seizure). Expect to see more indications that other financial companies with capital shortfalls are falling under the government umbrella.

Related posts:

• Bank by bank breakdown of stress test results
• BofA, Citi, Wells and GMAC biggest losers in stress test leaks
• GMAC: Loosening credit standards in the teeth of recession
• GMAC gets a helping hand
• GMAC chairman resigns effective immediately

I just came across a post on Zero Hedge called “An Overview Of The Fed’s Intervention In Equity Markets Via The Primary Dealer Credit Facility.” Now, that’s a mouthful. As far as I can discern, the post’s purpose is to expose alleged equities market manipulation by the Federal Reserve. However, I found the argument rather conspiratorial. And despite claims of an alleged smoking gun, there is no evidence in the post that that Federal Reserve is manipulating anything except interest rates. And the Fed made clear that that was what it intended to do.

Let me break down the argument made by Zero Hedge’s Tyler Durden and give a few remarks of my own on how I read the situation.

The junking of the Fed’s balance sheet

In March 2008, the Federal Reserve established the Primary Dealer Credit Facility (PDCF) to provide liquidity to the financial sector after Bear Stearns collapsed. Overnight funding had become a key source of liquidity for banks looking for cheap money (short-term rates are lower than long-term rates).

But when crisis hit, the liquidity in overnight interbank markets dried up leading to collapse at Northern Rock in October 2007 and then Bear Stearns in March 2008, institutions which were recklessly overexposed to overnight funding. This was a market failure. The Federal Reserve, therefore, stepped forward, effectively taking the entire wholesale banking market onto its balance sheet. That is what all of the Fed’s liquidity provisions are about.

The problem most of us have with this and similar facilities is the PDCF’s collateral terms. In the past the Fed accepted treasuries. Now it was accepting a lot more (including some so-called toxic assets):

The PDCF will provide overnight funding to primary dealers in exchange for a specified range of collateral, including all collateral eligible for tri-party repurchase agreements arranged by the Federal Reserve Bank of New York, as well as all investment-grade corporate securities, municipal securities, mortgage-backed securities and asset-backed securities for which a price is available.

By April 2008, when David Einhorn questioned Lehman’s earnings report, people were asking if they were going the way of Bear Stearns (see my June 2008 post “Is Lehman the next Bear Stearns?”). When Lehman did collapse, acceptable collateral expanded. In some instances it included equities as well. The Fed’s press release expanding collateral said:

The collateral eligible to be pledged at the Primary Dealer Credit Facility (PDCF) has been broadened to closely match the types of collateral that can be pledged in the tri-party repo systems of the two major clearing banks. Previously, PDCF collateral had been limited to investment-grade debt securities. The collateral for the Term Securities Lending Facility (TSLF) also has been expanded; eligible collateral for Schedule 2 auctions will now include all investment-grade debt securities. Previously, only Treasury securities, agency securities, and AAA-rated mortgage-backed and asset-backed securities could be pledged.

You’ll notice nowhere in the press release does one see the term equities. This is obviously by design because the Fed was under fire for bloating its balance sheet with junk. This process – what I call qualitative easing – was meant to be opaque.

With the panic now over, things have settled down and these facilities are likely to end. The Fed is issuing its own research to give intellectual cover to these activities. But, outrage remains nonetheless. The Fed’s own Charles Plosser, the President of the Philadelphia Fed, has said he wants to see qualitative easing end sooner rather than later. And Bloomberg News is suing the Federal Reserve under the Freedom of Information Act to reveal who it is lending money to against this dubious collateral.

That sums things up in a nutshell.  The key to note here is that the PDCF is an overnight lending facility, the TSLF is a 28-day lending facility and another program, the TALF, is a third longer-term lending facility I haven’t discussed. (See more on the TALF here and why it is a bailout).

Tyler Durden’s beef: the Plunge Protection Team

Tyler’s history of events in his post is largely consistent with what I just presented. Where his history diverges from mine is when he goes into the section headed “Implications,” saying “the Federal Reserve has now managed to singlehandedly take over the entire capital market.” At some point, he goes as far as to say:

The bolded text is all you need to know to find the smoking gun for any and all allegations of "plunge protection" or however one wishes to frame the invisible market bid.

Those are pretty strong words and I believe these claims are unsubstantiated in the post.  Why not leave it at the lesser claim that the Federal Reserve is running a loose monetary policy that encourages excessive risk – something that, while subject to interpretation, is a valid criticism?

Posts like this are exactly why I expressed concern when Bloomberg fecklessly expunged a Tyler Durden interview in August amid media hoopla over his identity:

Zero Hedge is a site replete with copious information on finance and the economy and is often a necessary voice of scepticism in the blogosphere that keeps the mainstream media honest.  We need outlets like that.  And Tyler was on Bloomberg Radio in the first place because he has something to say that is different, interesting and adds value. However, the hyperbole, tone, anonymity and confusion as to which writer is using which pseudonym at Zero Hedge has long become a liability which reduces the credibility of the site.

The claim of equity market manipulation strikes me as hyperbole.  There is no smoking gun whatsoever. It is a theory that I don’t buy into and that is not substantiated by the evidence in the post. Otherwise, Tyler and I are on exactly the same page.

I do have a few other points of disagreement.

• Why talk about the Primary Dealer Credit Facility when it is an overnight facility? The haircut is usually reset daily. How much manipulating can the Federal Reserve really do with an overnight facility? As I see it, the real problem with the Fed’s balance sheet is the loans under longer-term facilities like the TALF.
• What about the haircut on other asset classes, namely investment-grade and non-investment grade asset-backed securities and collateralized debt obligations. Forget about the plunge protection team conspiracy. To my mind, this is the real story here. The Fed says it accepts only securities “for which a price is available” as collateral. Is that really true? I am sceptical, one reason I would like to see who is getting these loans and what kind of collateral they are using.

Somehow you get the feeling there is a reason these facilities are still around, namely that some institutions need them because their capital base is so impaired right now that they would fail without the Fed taking those toxic assets off their hands.

In the end, Charles Plosser, Tyler Durden and I all agree: the Fed needs to end these programs as soon as possible.

Expect more on this issue soon via Marshall Auerback.

Update: This phrase, "PDCF usage declined, reaching zero in mid-May 2009," suggests the PDCF is not being used to goose equities. The quote comes from page seven of the following PDF document at the New York Fed from August: "The Federal Reserve’s Primary Dealer Credit Facility."

Related posts:

• Will banks exiting TARP take back their toxic waste now?
• TALF: A bailout if one reads the fine print
• A few words from a reader on TALF mechanics
• Understand the Fed’s balance sheet
• Bloomberg News sues the Fed under Freedom of Information Act

David Einhorn delivered a speech at the 2009 Value Investing Conference that is creating a lot of buzz in the blogosphere. He said a lot of interesting things about the investing and political climate.  A surprising amount of it comes out of the playbook here at Credit Writedowns.

Below are the quotes I want to highlight for you. At the bottom is an embedded copy of his speech.

Enjoy.

On short-termism in politics and government

Winston Churchill said that, “Democracy is the worst form of government except for
all the others that have been tried from time to time.”

As I see it, there are two basic problems in how we have designed our government.
The first is that officials favor policies with short-term impact over those in our long-term
interest because they need to be popular while they are in office and they want to be reelected. In recent times, opinion tracking polls, the immediate reactions of focus groups, the 24/7 news cycle, the constant campaign, and the moment-to-moment obsession with the Dow Jones Industrial Average have magnified the political pressures to favor short-term solutions. Earlier this year, the political topic du jour was to debate whether the stimulus was working, before it had even been spent.

On crony capitalism and regulatory capture

The second weakness in our government is “concentrated benefit versus diffuse harm” also known as the problem of special interests. Decision makers help small groups who care about narrow issues and whose “special interests” invest substantial resources to be better heard through lobbying, public relations and campaign support. The special interests benefit while the associated costs and consequences are spread broadly through the rest of the population. With individuals bearing a comparatively small extra burden, they are less motivated or able to fight in Washington.

In the context of the recent economic crisis, a highly motivated and organized banking lobby has demonstrated enormous influence. Bankers advance ideas like, “without banks, we would have no economy.” Of course, there was a public interest in protecting the guts of the system, but the ATMs could have continued working, even with forced debt-to-equity conversions that would not have required any public funds. Instead, our leaders responded by handing over hundreds of billions of taxpayer dollars to protect the speculative investments of bank shareholders and creditors. This has been particularly remarkable, considering that most agree that these same banks had an enormous role in creating this mess which has thrown millions out of their homes and jobs.

Like teenagers with their parents away, financial institutions threw a wild party that eventually tore-up the neighborhood. With their charge arrested and put in jail to detoxify, the supervisors were faced with a decision: Do we let the party goers learn a tough lesson or do we bail them out? Different parents with different philosophies might come to different decisions on this point. As you know our regulators went the bail-out route.

On misdirected anger on main street

And the neighbors are angry, because at some level, Americans understand that the Washington-Wall Street relationship has rewarded the least deserving people and institutions at the expense of the prudent. They don’t know the particulars or how to argue against the “without banks, we have no economy” demagogues. So, they fight healthcare reform, where they have enough personal experience to equip them to argue with Congressmen at town hall meetings. As I see it, the revolt over healthcare isn’t really about healthcare, but represents a broader upset at Washington. The lack of trust over the inability to deal seriously with the party goers feeds the lack of trust over healthcare.

On breaking up too-big-to fail institutions

The proper way to deal with too-big-to-fail, or too inter-connected to fail, is to make sure that no institution is too big or inter-connected to fail. The test ought to be that no institution should ever be of individual importance such that if we were faced with its demise the government would be forced to intervene. The real solution is to break up anything that fails that test.

The lesson of Lehman should not be that the government should have prevented its failure. The lesson of Lehman should be that Lehman should not have existed at a scale that allowed it to jeopardize the financial system. And the same logic applies to AIG, Fannie, Freddie, Bear Stearns, Citigroup and a couple dozen others.

There is MUCH MUCH more below.

Einhorn Vic Speech 2009

Related posts:

• UK: Darling confirms government to break up too big to fail banks
• Too big has failed
• Congressional response to AIG is mindless
• The failure to address the looming too-big-to-fail issue
• Lessons from Lehman

The title of this post is somewhat misleading – designed to be provocative to get you to read what I have to say. Indeed, I am going to defend Goldman Sach’s right to pay what it likes to its employees. But, I am also going to defend your right to be outraged and to look for redress.

Socialism?

Let’s start this off with another provocative statement which encapsulates my thinking on the issue:

The teabaggers who showed up in the summer at Town Hall meetings to shout down politicians and scream ‘socialism’ at anyone who would listen because Barack Obama was going to pull the plug on granny need to redirect their anger. By socialism I take it they mean central planning in a capitalist society. If they want to see socialism in action, look no further than banking.

Yes, that’s how I want to lead into this issue.

Let’s state the obvious: banking is a legally sanctioned cartel. In the US, the federal government by law has nominal control over the entire monetary and lending apparatus- both the printing press and interest rates – via the Treasury and the Federal Reserve respectively. The state and federal government also control who gets to be a bank by accepting and rejecting applications for bank charters and seizing banks which fail to meet their obligations as safe and sound lending institutions.

Let’s call this what it is: socialism.  One can argue whether this is the right way to run a banking system. But let’s put that (ideological) argument aside and focus on the specific issue of bonuses within that system – and whether the government’s controlling them is ‘socialism’ and whether we should accept that control.

Should the government Get to dictate who gets how much in the financial sector?

Goldman’s bonuses?

When Goldman Sachs reported record profits for the third quarter of this year, they also told us they were setting aside a record amount of money to pay bonuses.  Goldman’s record bonuses were not the only signs of champagne and caviar on Wall Street: JPMorgan Chase reported preparations for huge payouts as well. Even Citi and Bank of America are poised to pay billions. Over in the UK, the same is also true in the City of London, one reason London residential property prices are rising. Bankers are poised to make tens of billions.

Meanwhile, in the real world, the unemployment rate is still rising, we are seeing record numbers of foreclosures, and households are struggling with unprecedented levels of debt. And much of this has to do with the the inability or unwillingness to lend by those same bankers, many of whom are making millions individually. Clearly, there is something wrong with this picture.

The Obama Administration, which helped orchestrate a bailout of the banking system as the first priority when it came into office, has been asleep at the wheel quite frankly. It should have been patently obvious to them that bailing out the bankers while allowing them to pay themselves billions in the middle of a depression was going to create a backlash, ruin their credibility as agents of change and sow the seeds of a Democratic Party nightmare in 2010.

Obama has wasted political capital bailing out the financial sector. This is why people were yelling socialism at town meetings when Obama wanted to pass healthcare reform – something you should see as misdirected anger which the health insurance lobby is all too willing to exploit. What’s funny is that the bailouts are not just killing Obama’s street cred; they are also poisoning the chalice on Wall Street. Big bank CEOs – to a name – spited the man by not showing up at his big financial reform speech. And bankers are not ‘happy’ with Obama for having received their bailouts as political contributions are down.

At least they are beginning to realize their mistake. They are now admitting publicly that even Goldman Sachs would not exist except for the largesse of government. Witness these comments from Larry Summers as reported by Paul Krugman on Monday.

There is no financial institution that exists today that is not the direct or indirect beneficiary of trillions of dollars of taxpayer support for the financial system.

But, what are you going to do about it?  Are you going to try to cap bonuses?  How about a windfall tax as has been proposed in Britain. This is where I say “keep your hands off Goldman’s bonuses.”

Capping pay

Is capping pay a legitimate way to run an industry?  Paul Krugman thinks so:

I was startled last week when Mr. Obama, in an interview with Bloomberg News, questioned the case for limiting financial-sector pay: “Why is it,” he asked, “that we’re going to cap executive compensation for Wall Street bankers but not Silicon Valley entrepreneurs or N.F.L. football players?”

That’s an astonishing remark — and not just because the National Football League does, in fact, have pay caps. Tech firms don’t crash the whole world’s operating system when they go bankrupt; quarterbacks who make too many risky passes don’t have to be rescued with hundred-billion-dollar bailouts. Banking is a special case — and the president is surely smart enough to know that.

All I can think is that this was another example of something we’ve seen before: Mr. Obama’s visceral reluctance to engage in anything that resembles populist rhetoric. And that’s something he needs to get over.

It’s not just that taking a populist stance on bankers’ pay is good politics — although it is: the administration has suffered more than it seems to realize from the perception that it’s giving taxpayers’ hard-earned money away to Wall Street, and it should welcome the chance to portray the G.O.P. as the party of obscene bonuses.

Equally important, in this case populism is good economics.

No, it’s bad economics.

Here’s an idea:

You, down the street, packing and hauling those boxes –everyone else in the city is making $27,000 for packing and hauling. You’re making $43,000. I don’t care if your company is more profitable — that’s too much. We’ll leave you a little upside but not THAT MUCH upside. Your pay is officially capped at $37,000.

Is that what you want?

You say:

Edward, it’s different with bankers. They’re just greedy. They don’t need the money for basic necessities like food, rent and utilities.

Neither do Madonna, Will Smith, or Tiger Woods. Should we cap their pay too?

You say:

Well, no. They earned the money. The bankers are greedy. Greed is not good. It is excess and it needs to be stopped. it’s just not fair.

Now, you are on to something.

The issue is the bailouts

The problem here is fairness.  What you have here is a case where bankers have received huge wads of taxpayers’ money to save them to perform their central roles in supporting economic growth as lenders and depositary institutions.

The populist take: The banks took the bailout money and, instead of lending, they went out, leveraged up, and put their casino money in proprietary trading, mergers and acquisition and broker dealer activities. Then they paid themselves record – not just large, but record – bonuses with our money.  It is theft, plain and simple.

I hope I have the sentiment about right.  I share those sentiments. 

The question again is: what should we do about it? The position that government can just arbitrarily reach into some private enterprise’s internal affairs and make individual decisions on its behalf is indefensible. That is not how capitalism should work and I am not buying into that argument.

What should have been done when Obama came to office in the first place is bankrupt organizations should have been seized and broken up, sold, recapitalized or liquidated. That is what was discussed in February as nationalization, but what I call pre-privatization. If insolvent big banks had been seized during the panic, all contractual obligations would have been rendered null and void. There would have been no $100 million payout for Andrew Hall, no billions in bonuses, nothing.  The slate would be wiped clean and the government as temporary owner (and a bankruptcy judge) could briefly decide who gets what before the assets were disposed of. And of course, all of the other problems like overcapacity, lower lending to protect weak capital bases, excessive risk taking would have disappeared as well.

But, that never happened because the Obama Administration and Congress are captured. Rahm Emanuel is famously rumored to have said ‘never waste a crisis.’ Well, guess what? Your administration just wasted a crisis. As for capture, call it kleptocracy. Call it corporate communism. Call it crony capitalism. Call it whatever you want – that ship has sailed. We never took over the banks. We never demanded a say on pay in exchange for government backstops. We gave the banks everything they wanted with no strings attached. Oh, there was the stress tests. But the stress tests were a sham right from the word go. Irrespective, the government has no legal authority to reach inside Goldman Sachs and start dictating pay any more than it has authority to do the same at your company.

What the government has the power to do is four things:

1. Break up the big banks
2. Start regulating the banking industry properly.
3. Prosecute fraud and criminality in banking.
4. Set up a proper too-big-to-fail resolution process to seize bankrupt large financial institutions.

What can you do?

1. Stay informed.
2. Speak out.
3. Show politicians you want real change.

Financial Reform Poll Memo

Related posts:

• Goldman loses $2.1 in the third quarter
• Goldman partners get margin calls
• Forget about Goldman
• Goldman and Morgan Stanley are now banks
• Obama and health care: Wasting political capital

Ireland has made heroic strides in trying to deal with its economic problem after a spectacular property bust. But it is looking increasingly like it will not be enough. According to a senior Irish minister, the next stop for Ireland could be the International Monetary Fund (IMF) for a bailout.

The crisis has been building for some time and I have documented some of the milestones here over the last 16-odd months.

• Jun 2008: Ireland: government blew the boom
• Sep 2008: Ireland guarantees bank deposits at six banks
• Nov 2008: Is Ireland the next Iceland?
• Dec 2008: Irish equities suffer largest losses in 215 years
• Feb 2009: Do BRICs (and Germans) Eat PIGS?
• Jul 2009: Depressionary bust in Ireland is echoed in California
• Aug 2009: Government banking Irish edition

Its bad bank – called the National Asset Management Agency (NAMA) – is the most ambitious of its kind and harkens back to the Swedish crisis solution of the early 1990s.  They are truly trying everything they can to revive their economy.  But, a fiscal crisis is looming.

A Fistful of Euros reports:

In April, a supplemental budget that was supposed to settle things for the rest of 2009 forecast a general government balance of -10.75 percent (of GDP) for 2009 and 2010.  Assuming the same package of cuts as the April budget did, the respected Economic and Social Research Institute has just forecast deficits of close to 13 percent for 2009 and 2010.  2 percent of GDP went missing from revenue projections over a few months.  To give credit where it’s due, the IMF never believed the government’s deficit forecasts even at the time they were formulated and forecast deficits of 12 percent in 2009 and 13 percent in 2010.

How big a deal is 2 percent of GDP?  Well, the Irish government has told the European Commission that it will have the deficit down to the Maastricht level of 3 percent of GDP by 2013.   Since the macroeconomic framework for Budget 2010 has already been set, that’s 3 budgets to achieve a fiscal adjustment of 10 percent of GDP, and formulated in the context of inability to reliably forecast tax revenue even 6 months ahead of time.   And the new forecasts allow for a relatively benign global environment relative to the dire projections of earlier in the year, so this is specifically a crisis within the Irish Exchequer.

There is zero chance the Irish are going to be able you make a fiscal adjustment of 10% of GDP in 3 years in a weak economic environment. And we know where this type of policy leads by looking at Latvia.  So, now it seems government officials are finally coming clean and admitting, much as Latvia has done, that the only way out of this fiscal crisis is a bailout plain and simple.

The FT reports:

A senior Irish minister has for the first time warned Ireland could be forced to go to the International Monetary Fund for help if the country cannot implement the necessary cuts in the December budget.

The bleak assessment by Mary Harney, health minister, and former deputy prime minister, was one of several ministerial warnings on Friday choreographed to bolster public opinion for what is set to be harshest budget in the country’s 88-year history.

Mrs Harney, a leading economic reformer, said: “We’re spending €500m a week more than we’re raising. That’s an unsustainable situation.

“If the government hasn’t the capacity to do what’s needed, then others will come in like the IMF and overnight they will make decisions.”

Given the fixed exchange rate into which Ireland is locked via the Euro, there will be no competitive currency devaluation.  So the spectre of banking collapse is still a force with which to reckon. Monies from the IMF will certainly reduce the risk.

Related posts:

• Trouble in Ireland as Fitch cuts debt two notches to AA- and deficits soar
• Ireland guarantees bank deposits at six banks
• Ireland nationalizes Anglo Irish bank
• Irish unemployment gaps up by most in 40 years
• Ireland: government blew the boom

Marshall Auerback here.  I want to add a few thoughts on the situation in Latvia which Ed has highlighted on several occasions. His allusion to Argentina to describe the situation in the Baltics last July was on the money. I have a solution here out of the Argentine playbook.

In Latvia, the neo-liberal insanity continues.  The EU and IMF have told the government to borrow foreign currency to stabilize the exchange rate to help real estate debtors pay the foreign-currency mortgages taken out from Swedish and other banks to fuel its property bubble, raise taxes, and sharply cut back public spending on education, health care and other basic needs to “absorb” income. Higher taxes are to lower import demand and also domestic prices, as if this automatically will make output more competitive in export markets.

But Latvia doesn’t produce much to export. The Baltic States have not put in place much production capacity since gaining independence in 1991. Latvia, like other post-Soviet economies, has scant domestic output to export. Industry throughout the former Soviet Union was torn up and scrapped in the 1990s. (Welcome to victorious finance capitalism, Western-style.) What they had was real estate and public infrastructure free of debt – and hence, available to be pledged as collateral for loans to finance their imports. Ever since its independence from Russia in 1991, Latvia has paid for its imported consumer goods and other purchases by borrowing mortgage credit in foreign currency from Scandinavian and other banks. The effect has been one of the world’s biggest property bubbles – in an economy with no means of breaking even except by loading down its real estate with more and more debt. In practice the loans took the form of mortgage borrowing from foreign banks to finance a real estate bubble – and their import dependency on foreign suppliers.

So instead of helping it and other post-Soviet nations develop self-reliant economies, the West has viewed them as economic oysters to be broken up to indebt them in order to extract interest charges and capital gains, leaving them empty shells.

The sad part about this whole episode is that Latvia’s problems could be fixed over a weekend. Here’s what I would do:

1. Drop the peg to the euro, which functionally acts like an gold standard external constraint.
2. Don’t answer the phone when the foreign creditors call the government.
3. Have the banks declared insolvent, convert their external debt to equity, and then have them reopen that way on Monday with full deposit insurance guaranteed in the now free floating local currency.
4. Enact a 0% rate policy (use fiscal policy to regulate demand going forward).
5. Offer a local currency minimum wage job that includes healthcare to anyone willing and able to work as was done in Argentina after the Kirchner regime repudiated the IMF’s toxic package of debt repayment.

Full employment and economic prosperity would come in no time at all.

The last line is the key.  Improve employment and aggregate incomes and demand follows – as does creditWORTHINESS.  At the final stage, credit will follow.

Even a banker can figure that one out.

Related posts:

• China is set up for a big fall
• China issues bonds to “promote the RMB in neighbouring countries”
• Bloomberg talks Eastern Europe as Latvia downgraded
• Latvia as the new Argentina redux
• China can handle collapse of speculative inflows

The banks have been the ones benefitting most from free money via the Federal Government and U.S. taxpayers.  Given 9.8% base unemployment and 17.0% comprehensive unemployment, it is a bit galling for ordinary Americans that these same institutions are making record profits and poised to hand out record bonuses. Detroit is one of the hardest hit cities with the base rate of unemployment a depression-era 17.1% that is the highest in the nation. People who have watched corporations hoover up the handouts are desperate for some relief.  They are finally getting some (hat tip Andrew):

Thousands hoping to get applications for federal help on rent and utility bills turned Cobo Center into a chaotic scene today.

They came by foot, wheelchair, bicycle and car. About six left by ambulance after tensions rose and people were trampled, according to a paramedic on the scene. One unfortunate soul got his car booted.

Detroiters were trying to pick up 5,000 federal assistance applications from the city at Cobo because Detroit received nearly $15.2 million in federal dollars under the Homeless Prevention and Rapid Re-Housing Program, which is for temporary financial assistance and housing services to individuals and families who are homeless, or who would be homeless without this help.

People in wheelchairs and others using canes were being leaned on by people too weak to stand. Emergency medical technicians on the scene said they treated applicants who were injured during the rush to get inside the venue.

That’s what happens when a town full of broke people gets a whiff of free money, said Walter Williams, 51, who came before the sun to get an application and a shot at some federal assistance.

"This morning, I seen the curtain pulled back on the misery," he said. "People fighting over a line. People threatening to shoot each other. Is this what we’ve come to?"…

Yes, this is what we’ve come to.

Response had been so great that Detroit police and fire officials considered shutting down the process because of the volume of people.

Kelley Turcotte, a Detroit dishwasher, was near the end of the line around 10:30 a.m. today. The 27-year-old just had a son and said he is only squeaking by on his bills.

"I hope the government sees this and realizes the city needs a lot more help than they are giving," Turcotte said…

"This absolutely is representative of the struggling middle class in America," he said. "We’ve been betrayed by the government, Realtors and those who’ve got. The promise has been broken."

And you’re telling me this is not a depression?

Source

Chaos at Cobo: Detroiters turn out for federal help – Detroit News

Related posts:

• Paulson is handing out free money like candy to a baby
• GM and Chrysler to get more bailout money
• Volkswagen: if the American carmakers can get bailout funds, so can we
• Ten eastern European countries now looking to IMF for bailouts
• GM looks to use US and Canadian tax money to bailout Opel

A friend sent me the following article from USA Today:

The U.S. taxpayers’ investments in smaller banks are increasingly at risk.

In a sign that more banks are under great pressure from the recession, 34 financial institutions did not pay their quarterly dividends in August to the Treasury on funds obtained under the Troubled Asset Relief Fund (TARP). The number almost doubled from 19 in May when payments were last made, and also raised questions about Treasury’s judgment in approving these banks as "healthy," a necessary step for them to get TARP funding.

"The banks are not paying their dividends because they are worried about preserving capital," says Eric Fitzwater, associate director of research at SNL Financial.

The Treasury Department says it cannot force an institution to pay dividends. "For some banks, it may be prudent to exercise their right not to pay dividends in a particular month, and we respect their right to do so," says Meg Reilly, a Treasury spokeswoman. "To draw any broader conclusions about the state of the banking sector from one month is highly premature and speculative."

Dividend payment is not enforceable by law. The government has to accept a ‘cut’ in its dividend payment just like private investors do.  What is interesting is I wrote about this problem of capital constrained banks’ inability to pay TARP dividends back in January:

Honestly, I do not know how to sidestep this issue because the government should be compensated for its efforts as a normal investor would.  Zero-coupon bonds would generate the same accounting effect, even though no money was changing hands.  Payment-in-kind (PIK) preferred shares would be seen as inadequate.  Common stock would be dilutive to existing shareholders and is one reason not to hold stock in these companies.  Converting dividend-paying preferred shares into common stock may be the best route forward.

If anyone has a solution, feel free to chime in.

And, of course we know that the government has indeed converted their pref shares at Citi into common. Is this what we are likely to see at these smaller institutions as well?  I see this as further evidence that many banks are still very-much capital constrained.

Related posts:

• TARP dividends are killing bank profits
• Why is General Electric paying a dividend of 10%?
• The Citigroup Bailout
• Dividends are under pressure
• At least six banks need more capital under stress tests

Hank Paulson and Ben Bernanke told us when the Troubled Asset Relief Program (TARP) was launched that they were not concerned about the health of our banking system.  In fact, this was not the case. They were concerned about specific institutions and the overall health of the system. The U.S. financial system was much weaker than we were led to believe as I indicated at the time.

Now the TARP Special Inspector Neil Barofsky is telling the American people what many of us knew all along. Listen to what he says in the video below with MSNBC’s Dylan Ratigan. His contention that these false premises undermined the credibility of TARP and subsequent government economic policy rings true. Even today, we don’t know what the banks are doing with their TARP funds.  If they are loaning it out, why is the unemployment rate 9.8%?

By the way, I love D-Rat. This is a guy who likes to talk – god bless him. Sometimes he goes on way too much, but I like his approach.

Related posts:

• US Bancorp CEO makes his case on TARP repayment
• Some banks not paying TARP dividends
• TARP dividends are killing bank profits
• Should foreign companies get TARP funds?
• Crony capitalism in U.S. banking bailout should end

The following is my translation of a much-discussed article that appeared in Swedish daily Svenska Dagbladet at the weekend.  This information was being withheld from the public and leaked at an inopportune moment.

Note that the Swedish government has secretly been preparing the banks for financial Armageddon, encouraging Swedbank into a rights issue which arguably was conducted under fraudulent pretenses – very reminiscent of Bank of America’s shareholder vote for the merger with Merrill Lynch.  In August, I asked “Why is Swedbank doing a second rights issue?.” Now we know.

This is the kind of thing that topples governments.

Secret meeting on the crisis in Latvian

Finance Minister Anders Borg has had secret talks with the major Swedish banks and warned of a near economic collapse in Latvia, Svenska Dagbladet has learned. A nightmare scenario for Swedbank and SEB.

Yesterday Anders Borg issued a stark warning to the Latvian Government that it must take its financial problems seriously.

The promised cuts must be implemented when the new Latvian budget is presented in late October, according to Finance Minister.

The international community’s patience is very limited, stressed Anders Borg at the summit of European finance ministers in Gothenburg where he hosts as the finance minister in Presidency.

His statement came after recent reports from Latvia on political divisions in the ongoing budget negotiations.

But for Swedish bank heads, Borg’s move came as no surprise. According to several independent sources, Anders Borg, over the last few weeks, has contacted the senior management of major banks and warned them of an acute political crisis in Latvia. This in turn can lead to both a devaluation and eventually a default. It is a kind of national bankruptcy, similar to what hit Iceland last fall.

In secret talks with Swedish banks, Anders Borg explained the growing pressure that exists within the International Monetary Fund (IMF) to force Latvia into a devaluation.

A collapse in Latvia would have serious implications for several major Swedish banks. With a devaluation the already high loan losses would explode overnight, especially because many Latvians have loans in euro, which would become significantly more expensive.

Swedbank has up to today lent 61 billion kroner to Latvian individuals and businesses. The figure for SEB is 40 billion, while Nordea has 30 billion in loans.

For Swedbank a possible devaluation would come at an especially poor time. The bank is currently in the middle of a second rights issue in which shareholders have been asked to put up 15 billion.

CEO Michael Wolf’s message to shareholders and customers has repeatedly been that the money would be used for offensive investments. To then have to deal with a severe national bankruptcy in one of its major markets and see new issue money disappear into a black hole would be a severe blow to the bank’s credibility.

That a serious crisis approaches in Latvia has already been flagged by Anders Borg in the budget he presented a few weeks ago. On page 99 he writes:

"Since it is difficult to safely assess Latvia’s ability to pay and with conditions for recovery, one cannot completely exclude the risk of a major default."

The background to the current situation is a crash in the Baltic economies. Latvia is just the worst hit. This year, the country’s GDP is to shrink by as much as 18 percent.

This led to a rescue package cobbled together at Christmas last year. The International Monetary Fund (IMF), the EU and the Nordic countries decided on payments totaling SEK 80 billion, of which Sweden accounts for 7 billion.

An essential condition for aid money, however, is that Latvia implement substantial cuts in order to get the economy in balance.

This means wage cuts for state employees in over 15 percent, including hospital closures and major tax increases.

In July of last year Latvia went to reduce their spending for next year’s budget by more than 7.5 billion crowns.  It opened the door to  a further one billion disbursements from the IMF and the EU.

But then, the domestic political situation deteriorated. The previous Latvian government fell in February and since then the country has been governed by a coalition of five parties. The Prime Minister is Valdis Dombrovskis.  Next year come elections again.

Two of the parties in this five-party coalition have now objected to the previously announced savings of 7.5 billion. Some want to go back on parts of the promise and believe that a reasonable savings is instead about 4 billion kroner.

The goal to save 500 million lats (7.5 billion kroner) is practically impossible to achieve without eliminating several parts of the economy, Vents Armands Krauklis from the influential Liberal Party, which sits in the government coalition, said the day before yesterday.

24 hours later came the response from the EU.

"Latvia does not have much room for maneuver; It must fulfill its letter-of intent," said Anders Borg yesterday in Gothenburg to the news agency Direkt.

Original Source

Hemligt möte om lettisk kris – Svenska Dagblaget

Also see my August post, “Zombie banks Scandinavian edition and the threat of too big to fail.” This problem looms even larger now.

Update 7 Oct 2009: minor translation corrections were made resulting from reader suggestion.

Related posts:

• Transferring Swedish bank risk onto Latvian taxpayers
• Sweden: competitive auto bailouts begin with Saab and Volvo
• Estonia and Latvia: headed for the rails
• Earnings results at Swedish banks show large writedowns in Baltics
• Violence erupts in Latvia

Bloomberg News editor-in-chief Matt Winkler wrote an Op-Ed in the Wall Street Journal yesterday explaining why he is after the Federal Reserve to come clean about it’s secret lending program during the height of the financial crisis.

Bloomberg has filed a lawsuit against the Federal Reserve to force the Fed to reveal the name of the banks it lent money to in this operation, something I first blogged about last November.  Last month, Bloomberg won its case in District Court. The Fed is now considering whether to appeal.

At issue is transparency in our financial system.  In the Op-Ed, Winkler puts it thus:

The law doesn’t allow the government to get away with secrecy based on a mere claim that some sort of damage would result if it released the information in question. To prevail, the Fed must “provide evidence that if the requested information is disclosed, competitive harm would be ‘imminent,’” Judge Preska wrote. The Fed must show that competitors would use against a bank the fact that it received federal dollars—that running to the government trough for sustenance would become a competitive disadvantage.

That isn’t an easy test, and with hundreds of billions poured into financial institutions, it shouldn’t be. What’s more, the Fed didn’t come close to meeting this test. All it offered in court were sworn statements from Fed employees speculating that borrowers might be labeled as losers. They said nothing about how competing banks might use the information.

The issue at stake here is understanding the financial crisis and its aftermath. The information Bloomberg is seeking is vital to that, and it belongs to all Americans. Bloomberg isn’t alone in saying so. Dow Jones, the New York Times, the Associated Press, Gannett Newspapers, Hearst, Advance Publications, and the Reporters Committee for Freedom of the Press have all expressed support for Bloomberg’s efforts and may join a friend-of-the-court brief if the decision is appealed.

Below is a Bloomberg News video in which Winkler discusses the case with Betty Liu. In his opening remarks, Winkler says the Fed was taking on an unprecedented role and that this requires transparency.

I agree because the Fed has been politicized through these actions. Its independence is now threatened because of it as the Federal Reserve Transparency Act of 2009 attests.

Related posts:

• Bloomberg wins Freedom of Information lawsuit against Fed
• Bloomberg News sues the Fed under Freedom of Information Act
• Latest update on Bloomberg suit against Fed
• Bloomberg News vs. Fed: Judgment against Fed attached
• Fed continues to stonewall in Freedom of Information Act suit

Below is a copy of the actual judgment in the Bloomberg News vs. Fed FOIA case.  The case is: Bloomberg LP v. Board of Governors of the Federal Reserve System, U.S. District Court, Southern District of New York (Manhattan), No. 08-9595.

Hat tip Barry Ritholtz and Zero Hedge.

Bloomberg FOIA Lawsuit Decision

Related posts:

• Bloomberg wins Freedom of Information lawsuit against Fed
• Bloomberg News sues the Fed under Freedom of Information Act
• Bloomberg News is still after the Fed for more disclosure
• Fed continues to stonewall in Freedom of Information Act suit
• Lawsuit: steering mortgage applicants could mean more writedowns

This just in from Bloomberg:

The Federal Reserve must make public reports about recipients of emergency loans from U.S. taxpayers under programs created to address the financial crisis, a federal judge ruled.

The case is: Bloomberg LP v. Board of Governors of the Federal Reserve System, U.S. District Court, Southern District of New York (Manhattan), No. 08-9595. I have written a number of posts on this topic, following the case since November of last year.

• Bloomberg News sues the Fed under Freedom of Information Act
• Fed continues to stonewall in Freedom of Information Act suit
• Latest update on Bloomberg suit against Fed

Reuters reported that Chief District Judge Loretta Preska of the federal court in Manhattan wrote a 47-page opinion today which said the Federal Reserve failed to demonstrate that disclosure would cause banks to suffer “imminent competitive harm” due to their using the Fed’s lending programs. "The board essentially speculates on how a borrower might enter a downward spiral of financial instability if its participation in the Federal Reserve lending programs were to be disclosed. Conjecture, without evidence of imminent harm, simply fails to meet the board’s burden,” she said in her opinion.

Monday’s ruling comes as lawmakers and investors demand greater disclosure in how the government manages a series of programs designed to lift the economy out of its deepest recession in decades. The case arose when two Bloomberg News reporters submitted requests under the federal Freedom of Information Act (FOIA) about actions the Fed took to shore up the financial system in 2007 and early 2008, including an expansion of lending programs and the sale of Bear Stearns Cos to JPMorgan Chase & Co. After the Fed resisted the request, Bloomberg sued to compel disclosure. Preska concluded the Fed "improperly withheld agency records in response to a FOIA request by conducting an inadequate search," she wrote. FOIA obliges federal agencies to make government documents available to the public, subject to various exemptions. Bloomberg News and the Fed did not immediately return requests for comment.

Consider this a major win for transparency and the rule of law. The Federal Reserve has been acting in the shadows in concert with the executive branch without proper oversight from elected officials in Congress. Had they stuck to their dual mandate concerning economic growth and inflation most people would not have become alarmed. However the Federal Reserve has been taking on a quasi-fiscal role that demands much more transparency. And now we are going to get it.

Related posts:

• Bloomberg News sues the Fed under Freedom of Information Act
• Bloomberg News is still after the Fed for more disclosure
• Fed continues to stonewall in Freedom of Information Act suit
• Latest update on Bloomberg suit against Fed
• Bloomberg News vs. Fed: Judgment against Fed attached

Both Latvia’s and Estonia’s debt ratings were downgraded by Standard and Poors.  Estonia was cut from A to A-, while Latvia was cut to BB+ to BB – its considered high yield securities aka junk bonds. This should come as no surprise as both countries have been in the news due to severe economic dislocations as they attempt to maintain currency pegs in the face of a severe debt deleveraging.

Latvia has been having severe difficulties getting its IMF monies disbursed due to the lack of fiscal belt tightening. Just today Latvia released dreadful economic news with statistics revealing a19.6% fall in gross domestic product. As macabre as the figures were, they were better than analyst expectations of a 22% fall. Nonetheless, S&P has decided to use this backdrop as an occasion to downgrade the country’s debt along with northern neighbour Estonia.

Win Thin, an analyst at Brown Brothers Harriman, had this to say about the downgrades (emphasis added):

Somehow, Lithuania escaped this time but it should have been cut from the current BBB, as we rate it BB- vs. actual BBB/A3/BBB.  The only surprise to us was that the downgrades weren’t deeper, as we see eventual junk status (below BBB-) for all three.  As we noted in our most recent FX quarterly, the ratings agencies have been overly generous with Eastern Europe, particularly the Baltics.  Our sovereign rating model puts Estonia at a BB/Ba2/BB rating, way below actual ratings of A-/A1/BBB+.  For Latvia, we rate it B- vs. actual BB/Baa3/BB+.  Others that are overrated in the region include Bulgaria (we rate it BB vs. actual BBB/Baa3/BBB-), Hungary (we rate it BB- vs. actual BBB-/Baa1/BBB, and Romania (we rate it BB vs. actual BB+/Baa3/BB+).

We fully expect Estonia, Lithuania, and Bulgaria to follow Latvia and Romania into IMF programs.  Our negative view on the Baltics still underscores our bearish calls on SEK given the high levels of Swedish banking exposure to the region, and helps explain why SEK was the worst performer today vs. USD and EUR… Just look at Latvia.  It just reported Q2 GDP as contracting 19.6% y/y vs. an 18% drop in Q1.  The banking regulator has reported that all overdue loans rose to 23.5% of total loans in June...  Those numbers will only get worse, as we see little relief in sight for the economy…

The long and short of it is: expect more pain in Latvia and Estonia, but also across Eastern Europe as well. As the global recovery seems to within reach, particularly in emerging markets, expect Eastern Europe to underperform.

Sources

Brown Brothers Harriman FX Team

Related posts:

• Baltics: Fitch downgrade and more downgrades to come
• Moody’s: Iceland, Latvia and Hungary in “fragile stabilization”
• A bearish view on Eastern Europe
• Hungary cut to a notch above junk by S&P
• CDS contracts and the implosion of several Eastern European economies

President Barack Obama was elected last year in a sizable victory over his Republican competitor. Bolstering his position was the huge Democratic majority in both houses of Congress. Given these advantages, combined with intelligence and his natural talent as an orator, the President could pretty much chart his own course.

He did so, immediately turning to the weak economy and the battered financial sector first. In his first days in office, Obama pushed through a sizable stimulus package, bailed out numerous financial institutions, and put into place a host of measures to prop up the banking industry at considerable cost to taxpayers.

The plan worked. The financial industry has roared back to life with huge profits and large bonuses all around as a result of the government’s largesse – well at least for most of the largest companies. The surviving large financial institutions are even larger and more dominant than before the crisis. Now, it is business as usual again on Wall Street. In this sense, Obama and his economic team have been very successful.

But at what cost?

While the captains of finance are deciding how to spend their bonus money, ordinary Americans are still losing their jobs and their homes. The economy is still in tatters.

People are angry about this juxtaposition. No wonder everyone is having a hissy fit about Goldman, the owner of allegedly market manipulating trading codes and winner of the Wall Street earnings parade.

So, as the President turns his sights to health care reform, he is finding a much chillier reception from the media, Congress and the American people.  In my view, this is not necessarily because of his presenting the wrong proposal at the wrong time. Obama has simply wasted too much capital on bailing out the banks and this has left him in a weaker position politically.

To be sure, there are many reasons one could find fault with the proposed health plan.  But, with tens of millions of Americans having no coverage, the time for change is now. We all know that Obama could have made those changes had he not bailed out the banks first. His mandate will have to be more limited now.

So, as the President continues his public relations blitz to pass his health care bill, I look at the spectacle with a certain sense of disgust, wondering what could have been if so much weren’t wasted on propping up our still ailing financial system.

Video below.

Related posts:

• The purpose of health care reform
• Christina Romer: The Economic Case for Health Care Reform
• Personal story on devastating loss of health care benefits
• Obama: knowing when to be an asshole
• Obama turned off Edwards

This comes from the Wall Street Journal:

Small-business lender CIT Group Inc. said "there is no appreciable likelihood" that it will receive fresh government support, suggesting that the company might instead seek to file for bankruptcy protection.

In a written statement issued after the market close, the company said it was "evaluating alternatives."

The company has been locked in talks with government officials and regulators during the past week in a bid to prop up its business. The reason for the lack of success in the negotiations couldn’t be immediately learned.

I’ll tell you what I think it is: CIT is not a well-connected Money-center bank.  It is merely a lender to small-and medium sized businesses.  So, that makes the Obama Administration opposed to giving it a helping hand.  Only the big banks deserve bailouts, apparently. Just ask Chrysler, GM or California. CreditSights says much the same thing.

"We believe not supporting the lender could carry with it the stigma that the government was more willing to bail out Wall Street than small businesses," analysts at research firm CreditSights wrote Wednesday.

Meanwhile, the beleaguered financial supermarket Citigroup is near a ‘secret deal’ with regulators about how to increase regulatory scrutiny of the company.  See the FT story here.

Despite my snarkiness, I do agree that CIT should fail. No more bailouts. So, the Obama Administration is doing the right thing.  But, of course, these decisions are always fraught with risk.  Consider this Obama’s Lehman Brothers.  Right now, all is well though, as today was a major market melt-up despite the halt in CIT shares this afternoon.

Below are some other takes on the same:

US stock and bond futures little changed after CIT statement – Reuters

CIT Says U.S. Support Unlikely, Studies Options With Advisers – Bloomberg

Obama Administration Denies Aid to CIT Group – Washington Post

CIT’s press release on the matter were pretty brief:

CIT Group Inc. (NYSE: CIT), a leading provider of financing to small businesses and middle market companies, today announced that it has been advised that there is no appreciable likelihood of additional government support being provided over the near term.

The Company’s Board of Directors and management, in consultation with its advisors, are evaluating alternatives.

Individuals interested in receiving future updates on CIT via e-mail can register at http://newsalerts.cit.com.

I guess they are more concerned about talking with their lawyers at Skadden Arps about bankruptcy, which is pretty much a lock at this point.

Related posts:

• The case of the dissident Chrysler bondholders
• AIG: the biggest quarterly loss in corporate history
• Lehman was bankrupt
• My take on the latest Citigroup bailout
• CRE: GMAC-related Capmark Financial near bankruptcy