A Banking Meltdown

January 20th, 2009

From Bloomberg:

“I’ve found that credit losses could peak at a level of $3.6 trillion for U.S. institutions, half of them by banks and broker dealers,” Roubini said at a conference in Dubai today. “If that’s true, it means the U.S. banking system is effectively insolvent because it starts with a capital of $1.4 trillion. This is a systemic banking crisis.”

Roubini is one of the few people who were right about the severity of the current crisis.  Why is the government not acknowledging that our banking system is insolvent?

The dirty secret since what was then called the subprime crisis began (those quaint days when our fearless leaders informed us that the crisis was contained to evil poor people defaulting and not mass idiocy by the nation’s bankers) is that our banking system is insolvent.  The occasional nationalization here and there (welcome to the fold, Fannie and Freddie!) and the drabs of money given out in the TARP program (which has generally been squandered on things like paying dividends to shareholders and one last round of bonuses) have done nothing to change the fact that the banking system in the US is, by and large, insolvent.

A quick glance at the Balance Sheets of companies like Bank of America, Citibank, or Morgan Stanley reveal a startling fact: these companies have trillions of dollars in assets.  Many of those assets were acquired during the boom using a lot of leverage.  A review of the value of your house or stock portfolio will give you a general idea as to how much those assets should be written down.  I trust Roubini to do the math on this one and he says $1.8 trillion in losses (half of $3.6 trillion) vs. $1.4 trillion in capital.  Since banks need a capital base to lend against, one should probably assume that the entire $1.8 trillion is needed just to get us back to a functioning and solvent banking industry.

Why don’t we require the banking industry to write down the value of their assets to true market values followed by an orderly liquidation of insolvent banks?  Is this not precicesly what the FDIC is set up to do?  Is it not possible for stock and bond holders to take a little bit of responsibility for bad investment decisions? 

It appears that the government believes that zombie banks and stagnation is better than the, gasp, idea of a few more banks failures.  The government must believe that the American people are not adult enough to calmly handle a mass restructuring of the banking system and instead would riot in the streets.  Either that or there are too many well connected bankers who have conned Washington into believing that the banking system must be protected at all costs. 

Certainly the banks are not being saved to maintain a functioning banking system.  The one thing most parties agree on right now is that the banking system is not functioning.  If that is the case, why keep this set of banks around?  The market today continued to wonder the same thing.    

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Should you buy Gold?

January 12th, 2009

Merrill Lynch says rich turning to gold bars for safety

Merrill Lynch has revealed that some of its richest clients are so alarmed by the state of the financial system and signs of political instability around the world that they are now insisting on the purchase of gold bars, shunning derivatives or “paper” proxies.

Rich investors are spurning gold exchange traded funds in favour of krugerrands.

Gary Dugan, the chief investment officer for the US bank, said there has been a remarkable change in sentiment. “People are genuinely worried about what the world is going to look like in 2009. It is amazing how many clients want physical gold, not ETFs,” he said, referring to exchange trade funds listed in London, New York, and other bourses.

“They are so worried they want a portable asset in their house. I never thought I would be getting calls from clients saying they want a box of krugerrands,” he said.  

Gold is in the news a lot these days.  Occasionally someone asks me if they should buy gold.  The response that I inevitably have, as with all such questions, is what are your goals?  If their goal is a quick trade because they think gold is going to increase in value, I tell them not to do it.  If their goal is protection against the dollar collapsing, that is a different story. 

Gold is not an investment.  Please repeat this three times and right it down so that you do not forget it.  Gold is insurance.  It is insurance against a financial apocalypse in your home country.  Ask people in Zimbabwe if they would prefer having their savings in Zimbabwean dollars or gold.  Or, if history is your thing, look at the history of the German mark during the, newly fashionable to talk about, Weimar Republic.  Sometimes governments lose control of their currencies and all hell brakes loose. 

There is increasing concern about that possibility amongst the savers in the world given the ongoing currency brinksmanship we are witnessing.  The savers of the world see the increasing loads of debt that countries across the globe are issuing and see the increasing amount of paper currency being created.  The odds of a major currency collapsing have risen and the idea of having all your money in rubles, euros or dollars suddenly seems less appealing.

Which gets us back to gold.  Owning gold is about possessing a store of wealth that is recognized and tradable all over the world.  If economic disaster or war ravages your home country, gold is a handy tool for bribing corrupt officials to get an exit visa, paying the fare for you and your family to catch the last boat or flight to some relatively safe nation and using the remainder as seed money to start a new life.

If you decide that you would like to buy a little insurance for your family, make sure you do it the right way: take physical possession of the gold you purchase.  In times of great financial strain, some genius in the government inevitably decides that it is the people’s patriotic duty to donate their gold to the government followed by the outlawing of private ownership of gold.  In that scenario the mandarin’s fondest hope must be that all the private owners of gold have conveniently stored their gold in a single place under the stewardship of some ETF.  I do not envy the head of a family who thinks he has protected his family against a collapse in the dollar only to receive a statement in the mail saying, “Due to unprecedented circumstances, the US government has taken ownership of all the gold in the GLD vault and has replaced it with 30 year US Treasury notes.  GLD will let all investors know the conversion rate of gold to Treasuries as soon as that information is shared with us.  We apologize for any inconvenience this may cause you.” 

 

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The Bank of England cuts rates to 1.5 percent

January 8th, 2009

From the FT: The Bank of England on Thursday urged the Treasury to hasten plans to ease the flow of credit to companies, as it cut official interest rates to a 315-year low of 1.5 per cent.

We have reached the inevitable outcome of Richard Nixon’s, and later the rest of the world’s, decision to ditch the gold standard in favor of, well, hope that your counterparty is honorable.  The venerable Bank of England who, through the South Sea Bubble, the rise and fall of Napolean and Hitler, revolution in America and numerous other wars and recessions, had never reduced its benchmark rate below 2.0% finally blinked and reduced its rate to 1.5%.  The era of currency brinksmanship rages on. 

In their attempt to dig themselves out of the mess they created, the Japanese were the first to employ this weapon in our brave, new hope based world.  Their thinking, I guess, was that if they could cheapen their currency they could export their way out of their pending economic collapse and avoid the painful restructuring that their economy needed to go through after the bursting of their stock and real estate bubbles.  Implementing this theory has resulted in nearly two decades of Japanese economic stagnation and has had the side benefit of helping to destroy the American auto industry (while US management incompetence is surely the primary reason a cheap yen didn’t help).  For some reason, no one in America seemed to care about this blatant currency manipulation through 0% Japanese interest rates and let it go on.  The Chinese saw something that seemed great and decided to follow suit.  Why not grow your manufacturing sector through a cheap currency if the Americans are willing to sacrifice their own manufacturing sector and allow it? 

Unfortunately, all good things must come to an end and the credit induced boom where the Japanese and Chinese allowed the US to run up bigger and bigger deficits while those two countries maintained a weak currency and absorbed large portions of the world’s manufacturing capacity has come to an end.  Blame sub-prime borrowers, inept politicians, greedy bankers, or whoever else you would like, but, whatever the catalyst, the boom is over.

So, what are poor Ben Bernanke and Henry Paulson to do?  God forbid they allow the US economy to painfully restructure, let bankrupt companies fail and let the free market do its work.  No, they have chosen the path of bailouts and that distinctly Japanese weapon: currency manipulation.

You shall not crucify mankind upon this cross of gold, indeed.  Why pay your debts back when you can simply inflate them away?  It is so easy.  You just turn on the printing presses a little at a time and, voila, at some point your debts have become manageable.  Nothing could be easier. 

The problem with the inflate away your debts philosophy, besides being a dishonorable and shameless thing to do, is that at some point the suckers in the game, foreign holders of your debt and currency, realize what you are doing and are forced to react.  They can react the way people have done throughout time, refusing payments in your currency and demanding gold, or they can engage you in your game of brinksmanship and crank up the printing presses in their own countries.  The later seems to be the path du jour.

What happens when every country in the world prints money with reckless abandon in an attempt to maintain the value of their dollar holdings in terms of their local currencies while at the same time avoiding a rapid strengthening of their own currencies and the resulting havoc in their manufacturing sectors?  Who knows?  This is one big experiment and now that even Mervyn King has bowed to the pressure and the Bank of England has joined the game in earnest, I guess the world will find out.

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The Bear - Tales from a Financial Panic

December 26th, 2008

The following is based upon unsubstantiated accounts.

EXT: SIDEWALK NEW YORK CITY

Ground floor view looking up at a skyscraper. 

The building is grey, gothic and mammoth.  An ornate sign over the entrance gives us the name of the owner of this building: JPMorgan Chase.

A date flashes at the bottom of the screen: March 13, 2008

INT: OFFICE LOBBY

Two men stand uncomfortably in front of a beautiful, red headed woman, BRONWYN HENDRICKS, who sits at a receptionist’s desk.  One man is bearded and bald.  The other is thin and boyish looking with floppy brown hair.  Each wears a cheap, ill fitting suit with shoes that don’t match.  These men are BEN BERNANKE and TIMOTHY GEITHNER.   

BRONWYN: Is Mr. Dimon expecting you?

TIMOTHY: Well, not exactly, you see…

BEN (cutting TIMOTHY off, somewhat franticly): We have to see him!

TIMOTHY: Just tell him it’s ol’ Timmy Geithner.

BEN (even wider-eyed and more frantic than before): We have to see him!

 BRONWYN (dubiously): Geetner and

BEN: Bernanke!

BRONWYN: OK, I’ll see.  Please sit over there while I check in with Mr. Dimon.

TIMOTHY: Remember to tell him it’s Timmy Geithner.

BEN: We have to see him!

TIMOTHY: Don’t worry, Ben. (Grabbing Ben by the shoulders and moving him to the waiting area.)  You see me and Jamie go way back.  Yes we do.  Jamie told me if I ever got into a fix I should call him up and he would take care of it.

BEN (Calming slightly):  He did? 

TIMOTHY: Now, you let me do all the talkin’, Ben.  I know these Wall St types.  They real tough.  Tough as nails, but I know how to speak their language.  

Out of the doorway of the office walks a tall, fit, good looking man.  He is impeccably dressed and groomed.  He stands straight, walks with confidence and oozes success.  He flashes a big, bright smile as he exits his office door and enters the reception area.  This is JAMIE DIMON.

JAMIE: Little Timmy Geithner.  What are you doing in these parts?  (looking at Bronwyn reproachfully) Bronwyn, how could you keep Timmy Geithner waiting?  Timmy’s an important man.

TIMOTHY: Ah gee, Jamie…

JAMIE: And what do we have here?  Is that Ben Bernanke?

BEN: We’re in a heck of a mess, Jamie!

TIMOTHY: Shush, Ben!  Yes, this is Ben.  Say hi, Ben.

BEN (embarrassed and downcast): Hi, Jamie.

JAMIE: A mess, huh?

TIMOTHY: No, no, Jamie.  Not a mess.  More like, um, we have a great opportunity for you.

 JAMIE: A great opportunity for me?  Come on in and tell me all about this great opportunity.  Bronwyn, get these boys a glass of Noah’s Mill.  Ice or neat, boys?

BEN: Is that alcohol?  I dunno if we should be drinking right now.

TIMOTHY (furiously to Ben): Ben!  Quiet! This is the way you do it on Wall St!  Yes, of course we would love some Noah’s Ark.  Neat is just fine.

JAMIE: Great.  Come right in.  Bronwyn, some Noah’s Mill for the boys and me.

BRONWYN: Yes, Mr. Dimon.

INT: JAMIE DIMON’S OFFICE.

Jamie walks in and sits behind a massive oak desk.  The office has expansive views of the New York skyline.   Ben walks in with mouth opened awe.

BEN: Wow.

Timothy and Ben sit in the guest chairs.

JAMIE: They say Mr. JP Morgan himself used this desk.  Really something, isn’t it?  Now, what is this about an (beat) opportunity?

BEN: It’s Bear, Jamie.  They can’t pay their bills…

TIMOTHY: Ben!

Bronwyn interrupts to drop off the drinks

TIMOTHY: Thanks.

Timothy takes a big sip of courage before restarting.

TIMOTHY:  It’s Bear, Jamie.  Jimmy Cayne, he’s got himself in a whole heap of trouble.

JAMIE: Jimmy? My mother was at a bridge tournament recently and saw him there.  She said he looked great.  Has something happened?

TIMOTHY: Oh, it’s this whole subprime mortgage thing, Jamie.  I guess, Jimmy, he got himself a little too deep in that stuff and now he needs some help gettin’ out.

JAMIE: Subprime?  I’m not sure I’m the right man for that.  I’m a simple commercial banker. 

BEN (animatedly): You have to help!

 TIMOTHY: Quiet, Ben.  Let me do the talking.  See the thing is Jamie, Bear is having some, um, short term cash flow needs and they need a little money, just for a little while mind you, or they may go (leans in and whispers) out of business. 

JAMIE: Short term cash flow needs?

TIMOTHY: Yes, exactly.  See, Ben and I here we was hopin’ that maybe you can help Bear out with a little loan. 

JAMIE: Golly, boys.  You know how much I would love to help, but I don’t think there is anything I can do.  I’m so busy right now.  (Gestures at the two files sitting on his desk) My wife is badgering me about re-doing the kitchen at our Hamptons place.  Bronwyn keeps pestering me to look at some plans for renovating the building lobby.  I’m burning the midnight oil around these parts.

BEN: Man, oh, man.  That is a lot of stuff.

TIMOTHY: (Losing his cool) Jamie, you have to… (Immediately calming himself down)   I mean, couldn’t you even check it out, Jamie?  It would mean the world to us.

JAMIE: I tell you what I’ll do.  Now, I’m going to get in trouble with Bronwyn over this, so you owe me big time, but maybe I can put that dang lobby renovation on hold and take Bear off your hands.

BEN: (Excitedly) You would do that for us?     

TIMOTHY: That’s great, Jamie.  And what are you thinking of paying for Bear?

JAMIE: Paying?

TIMOTHY: You know, what are you willing to pay for Bear to, uh, take them off our hands?

JAMIE: (Rubbing his chin) Well, I guess if you guys take, I don’t know, let’s say $30 billion of the worst assets off their books then it is one done deal.       

 BEN (Dumbfounded): $30 billion?

TIMOTHY: (Wiping sweat off his brow) $30 billion?  That’s a lot of money.   Well, I guess maybe we can do that.  Yeah, yeah, we can do that.  OK, how much will you pay then?

JD (Confused): Pay?

TG: For all the rest of the assets and liabilities?

JD: (Shaking his head) I’m sorry, guys.  I thought I had explained about the lobby renovation.  That is a big sacrifice.  Then there is also all the work of bringing the Bear guys over and teaching them the JPMorgan corporate song.  It takes a lot of work to get that song right.  I’m not sure you guys appreciate…

TG: Oh, no, Jamie.  It ain’t like that.  We totally understand.  Don’t we, Ben?

BEN (Nodding furiously):  We understand!

TIMOTHY: It’s just the taxpayer, Jamie.  Sometimes they don’t understand all this high finance and e-co-nomics talk.  Some reporter tells them that we gave Bear to JPMorgan while taking on $30 billion dollars in potential losses and they think we ain’t doin’ our jobs.  Ain’t that right, Ben.

BEN: The taxpayer, Jamie.  He just don’t understand all this finance and economics.

JAMIE: Hmm.  I guess that is a problem.  I know what a great job you all are doing and I would hate for some know nothing from the NY Times to get this all mixed up.  (beat)  I tell you what I will do boys. (Pounding his desk)  I will take on the first $1B in losses on that $30B portfolio.  How can anyone complain then?

TIMOTHY: Great.  OK, ok, and the shares?  How much will you pay for those?

JAMIE:  Man, you boys drive one hell of a hard bargain.  The board is going to crucify me for this one, but, for you little monkeys, I’ll do it.  I’ll give you 2 bucks a share.

TIMOTHY: Gee whiz, 2 dollars, Jamie.  You would do that just for us?  That’s mighty swell.  That’s mighty swell, ain’t it, Ben?

BEN: Oh, oh, great job, Tim.  Wait til we tell Paulson.  He’ll respect us then.  He’ll start letting us attend the big boy meetings after he hears about this.

 JAMIE: Ah, my reputation is going to be shot, but it’s a deal, boys. (Standing up and walking over to shake hands).  Bronwyn (calling out), pour a celebratory round for me and the boys.

Bronwyn enters and tops off everyone’s glass.

JAMIE: (holding up his glass) To Wall Street!

BEN and TIMOTHY together: To Wall Street!

The three men clink their glasses and take deep sips.

Fade to black.     

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