Wednesday, November 30, 2011

Small Banks Are Getting Smaller

Check out the Wall Street Journal article “Ax Falls at Smaller Banks.” ( And, the subtitle to the piece: “Cuts at Lenders as Industry Job Growth Slows: ‘There will Be More to Come.”

This article is right in line with my Monday post “While Small Banks Disappear, Big Banks Get Bigger.” (

“Smaller U. S banks and savings institutions are cutting jobs in a sign of a deepening financial industry retrenchment that is shaking firms from Main Street to Wall Street.”

“Banks that cut jobs in the third quarter outnumbered those that added jobs by 605, according to data from the FDIC.”

“Overall, banking industry employment rose slightly in the third quarter due to continued growth at the nation’s biggest banks.”

“Small banks are under especially intense cost pressure because they are as a group less efficient than larger rivals.”  And, they cannot achieve the economies of scale that larger banks can experience. 

“In the third quarter, about 76 cents of every $1 in revenue at banks with $100 billion or less in assets was consumed by expenses…. At the biggest banks, the figure was 58 cents.  The efficiency gap has widened by 50 percent in the past decade.”  

Many of the smaller banks just cannot compete in today's environment.

And, the recognition of the industry problems continues to grow as Standard & Poor’s “downgraded some of the world’s largest financial institutions.”  (

The line I like best in this article is “This is confirmation that rating agencies are lagging indicators.”  These downgrades should have taken place a long time ago.  But, I have written about this many times over the past three years and even suggested how market instruments might be used to provide an “early warning indicator” for the purposes of bank regulation. 

The banking industry still has a ways to go to regain its health.  Until then, the economic growth of the economy will continue to be mediocre…at best.

Tuesday, November 29, 2011

European Sovereign Debt Must Be Restructured

A debt crisis for an organization occurs when either its debt repayment cannot be covered by the cash flow being generated by the organization or the outstanding debt of the organization cannot be reduced sufficiently to reduce the debt repayment needs. 

In the case of a governmental organization, the cash flow needed to cover the debt repayment requirements comes from economic growth that is large enough to generate governmental revenues that cover the government’s cash outflow.

Or, the cash needed to reduce the amount of government debt outstanding comes from a cash surplus generated by the government’s prudent fiscal budgets.

If neither of these conditions is met, then the government is insolvent and the debt outstanding must be restructured.

What is so hard to understand?

The growth rate of many countries in the eurozone is exceedingly low or non-existent. 

The new budgets being generated in these countries do not reduce deficits sufficiently to reduce their ratio of government debt to Gross Domestic Product.

The current efforts of the effected governments produce a cumulative result that just exacerbates the situation.  If the deficits cannot be reduced sufficiently, the debt repayment crises continues which puts greater pressure on governments to reduce budget deficits, and so on, and so on.  The experience of the eurozone over the past few years just confirms this dilemma.   

This reality pervades the bond markets. 

But, this reality is still being evaded by eurozone officials. 

A movement to enact a “fiscal union” to go with Europe’s “currency union” cannot correct the current situation without a debt restructuring because it ignores the reality of what the current situation has inherited.

A “fiscal union” can only be achieved if, at the same time, a debt restructuring takes place in those nations that are fiscally insolvent.  That is, the resolution of the current problems can only be achieved when the fact of insolvency is dealt with AND some form of a “fiscal union” with sufficient power is put in place. 

The past must be dealt with and some hope must be established for the future.     

A debt restructuring will be costly because of the impact this restructuring will have on European banks…and other banks and financial institutions throughout the world.  Any new “fiscal union” combined with a debt restructuring must include some plans to “backstop” banks.  This “backstopping” may spillover into other countries, like the United States and the United Kingdom.

And, all of this will have further negative repercussions on economic growth…in Europe, in the Untied States, and elsewhere. 

As Milton Friedman warned, “There is no such thing as a free lunch.”  Well, it appears as if the “free lunch” we have been trying to live off of is just about over. 

Monday, November 28, 2011

Big Banks Get Bigger While the Smaller Banks Disappear

The FDIC released data on the state of the banking industry last week.  And, we see that the size and number of the bigger banks increase while the size and number of the smaller banks continue to decline.

Let’s look at the number of banks in the United States first.  The number of banks in the United States dropped by 61 from June 30 to November 30 leaving only 6,352 banks still in existence.  Note that the FDIC closed only 26 banks in the third quarter of 2011.

Over the past 12 months, the number of banks in the banking system dropped by 271 banks. 

Obviously, if we focus on just the number of banks that the FDIC closed, we are not getting the whole picture as many unhealthy banks that might eventually be closed are being acquired.

The number of banks on the FDIC’s list of problem banks dropped to 844 on September 30, down from 865 on June 30.  So, the number of banks on the problem list dropped by 21, the number of failed banks was 26, and the number of banks leaving the banking system was 61.  Seems like more banks went on the problem list than left it in the third quarter of the year.  Maybe the statistics on problem banks is not as "jolly" as indicated. 

Over the past 12 months, however, the largest bank classification, banks with assets in excess of one billion dollars rose by 10.  Banks with less that $100 million in assets declined by 176 over the past year and banks with assets between $100 million and $1.0 billion dropped by 105.

Whereas the average size of banks in these last two categories remained about the same over the past year, the average size of banks over $1.0 billion in rose by $1.5 billion to $22.0 billion.

At the end of September 2011, there were 2,208 banks that were less than $100 million in asset size and these banks represented about 1.0 percent of the assets in the banking industry.  On the same date, there were 3,626 banks with assets ranging from $100 million to 1.0 billion, and all of these banks just controlled slightly more than 8.0 percent of the assets in the banking industry.

There were 518 banks in the United States that had assets in excess of $1.0 billion, and these 518 banks controlled 91.0 percent of the assets in the banking industry.

In terms of loans, Net Loans and Leases at the smaller commercial banks declined by almost $8.0 million over the past year, by $2.5 million over the past quarter.  The Net Loans and Leases at the middle range of banks dropped by a little less that $50.0 million over the past year and by about $4.0 million over the past quarter.

In the larger banks, Net Loans and Leases increased by more than $70.0 million over the past year and by about $36 million over the past quarter. 

The bottom line is that commercial banks with assets totaling less than $1.0 billion continue to produce statistics that cause one to question the health of this segment of the banking industry.  In addition, given the decline in total assets in these banks, the sector has not observed a consistent reduction in noncurrent assets (past due loans).  That is, there has only been a modest reduction in the average amount of noncurrent assets to total assets over this time period. 

Consequently, the larger banks are getting larger and becoming more dominant all the time.  And, if one looks at Federal Reserve statistics, the largest 25 domestically chartered banks in the country control about two-thirds of all the assets held by domestically chartered banks.  Thus, if the largest 518 banks in the country control 91.0 percent of the banking assets, this means that 493 banks that are larger than $1.0 billion in asset size but are not among the 25 largest, control about 24 percent of the assets. 

All the statistics show that the small- to medium-sized banks are really becoming insignificant in the United States banking industry and, given the troubles that many of these banks still face, will become even less significant in the future. 

An article in the Monday edition of the Wall Street Journal presents research showing that the health of the banking industry is being questioned by the stock markets.  Andrew Atkeson and William Simon write that “The recent volatility in bank stocks is a signal that U. S. banks, large and small, are not as healthy as many analysts assume.” (

“The dynamic has played out twice before over the past 85 years—in the Great Depression and the panic of 2008-09—with devastating consequences for the broader economy.  Over the past three months, investor uncertainty about the soundness of bank balance sheets, manifested in the daily volatility of stock prices is back up to levels seen historically only in advance of these two great crises.”

“This extraordinary volatility is not limited to the stocks of large banks but extend to small and midsize banks as well.”

So much has been written about the condition of the banking industry in Europe.  Very little has really been written about the condition of the banking industry in the United States.  Investors in the stock market seem to have picked up this concern.

And, I have argued for more than two years now that the major reason that the Federal Reserve has pumped so much money into the banking system is that the United States banking industry has severe problems.  And, the fact that banks have held onto these funds as excess reserves and have not loaned them out is an indication of the fact that many of the banks are still not solvent.  However, the fact that the Fed has provided so many excess reserves to the banking system has allowed the FDIC to either close banks or approve acquisitions of weak banks as smoothly as possible.  The Fed and the FDIC have, so far, prevented any panic from occurring. 

However, problems remain. 

Tuesday, November 22, 2011

Deficit Reduction: An Absence of Leadership

I spend a lot of time writing…and talking…about the credit inflation that has taken place in the United States over the past fifty years.  In my mind, this period of credit inflation set the stage for the Great Recession of December 2007 through July 2009.  It also set the stage for the debt overhang that burdens the United States economy to this very day.  It also will account for the mediocre economic growth that the United States will experience for the next four or five years.

Essentially this credit inflation laid the foundation for all the private sector credit expansion that took place during this fifty-year period and for the financial innovation that dominated the country in the latter part of the last century. 

Over the past fifty years, the Gross Public Debt of the United States increased at a compound rate of growth of approximately 8.0 percent.  Private debt rose somewhere between a compound rate of 10.0 percent and 15.0 percent. 

All of these figures exceed the growth rate of the economy, which averaged a compound rate slightly in excess of 3.0 percent.

When credit growth exceeds the rate at which the economy can grow, that is called “credit inflation.”  A good portion of this credit inflation has gone into consumer prices, but even more has gone into asset prices, or, has gone offshore.

The Gross Public Debt stands around $15.0 trillion as of this last October.  In just the past three years this figure has grown by about $4.0 trillion.

If this pace is continued, the Gross Public Debt will rise by more than $13.00 trillion over the next ten years, slightly below the forecast I have been putting out for the last year or more, which is $15.0 trillion or more.  I have argued that, given current attitudes, the government’s debt outstanding will double in the next ten years. 

I feel much more comfortable, at this time, arguing that the debt will double in the next ten years than I do that the debt will increase by only 50.0 percent or 75.0 percent. 

I have very little faith, at the present time, that much will be done to divert us from the path that we are on.  And, just ten years ago we were experiencing a surplus in the government’s budget.

It comes as no surprise, therefore, that I am not surprised in the breakdown in the deficit talks of the Congressional supercommittee.  There is no leadership in Washington to bring about a change in direction.  The President’s ability to lead the situation is almost non-existent given the evidence of the recent polling data on support.  And, Congress is even less able to lead given that polls on the public’s confidence in it are substantially below that of the President. 

The problem, as I see it, is that the leadership style of the President is to state, in general, what he would like…a health care bill, a financial reform act, an increase in the debt ceiling, and a deficit reduction plan…and then turns it over to Congress to come up with a plan.

The Republicans in Congress knows that they will not be punished if they stand up and take a very intransigent position.  They have become very direct in this in the last two skirmishes, because they knew that there was no way they would be called out.   They learned this from the first events surrounding the development of the health care bill and the financial reform act.  The Democrats in Congress have just been left out to “hang”.  You really don’t hear anything from them anymore.  They know they have the weak hand. 

So, I continue to predict that the federal debt outstanding will grow…and grow…and grow.

And, as the debt continues to grow, the value of the dollar will continue to trend downward.  Over this time period the debt of the United States government has trended upwards. 

Since 1971, when the dollar was taken off the gold standard, the dollar has declined in value by about 33.0 percent.  Since 1971, the debt of the government has increased by 39 times.  The reason that the dollar has not declined by more is that other countries have followed policies that are similar to those of the United States and the U. S. dollar is still the reserve currency of the world.

As the debt continues to grow, the value of the dollar continues to decline.   Here is the chart of the value of the U. S. dollar against other major currencies over the last ten years.   

The chart begins near the start of the Bush (43) administration.  The two years previous to the beginning of the Bush (43) administration, the federal budget was in surplus.  As can be seen, the value of the dollar was about 10.0 percent above the level it was at the time the dollar was removed from the gold standard.  As federal deficits rose through the last decade, the value of the dollar continued to decline, reaching historic lows earlier this year. 

Thus, I continue to be a pessimist about the ability of the United States government to get its budget under control and I continue to be a pessimist about the future value of the dollar.  We cannot expect to see the value of the dollar really get stronger until we achieve some control over our fiscal affairs. 

Given this view about the future, I continue to be a pessimist about the ability of the United States to maintain its economic lead on the rest of the world going forward. (See for more on this.) Right now, that is the environment I believe businesses and investors should prepare for.

Monday, November 21, 2011

How Do You Cover Up Your Failure: the Greek Case

I believe that Gretchen Morgenson of the New York Times has done investors a big favor in writing her piece for the Sunday morning paper of November 20.  This article reveals the extent that officials will go to try and avoid the consequences of when they royally “screw up”! (

The situation: “the debt mess in Europe.”

The event: “bankers are pressing Greece’s bond holders to swallow big losses.”

The intended consequence: “Leading the charge is BNP Paribas, the big French bank, which has been hired by the Greed government to help persuade investors to accept a deal that would cut the value of their investments in half.”

The cover-up: “On paper, this restructuring would be voluntary!”

The reason for this behavior: the Credit Default Swaps that are supposed to cover the losses on a write down like this.  “If Greece stops paying after the restructuring (the swaps that investors bought as insurance on the Greek debt) are supposed to cover their losses, much the way homeowners’ insurance would cover a fire.” 

The effort: if the restructuring is declared voluntary then the “credit insurance may not pay off down the road, because after the restructuring is completed, the terms of the old debt might be changed.”

Who stands to gain: “BNP which stands to profit from the restructuring.”  BNP will “generate fees from the exchange” or is concerned about “its own exposure to Greece.  A question being discussed is whether or not “BNP Paribas has written a lot of insurance on Greek debt.  If so, getting people to unwind such swaps now would be less costly for BNP than having the insurance pay off.”

Most suspicious, an official of BNP Paribas, Belle Yang, is also on the “powerful” International Swaps and Derivatives Association (I.S.D.A.) “determinations committee” that will decide what constitutes a “credit event” both in Greece and elsewhere in Europe. 

When you don’t do your job, things happen.  And, when things happen and you deny that things are happening, things get worse.  And, when things get worse you sometimes do very stupid things in order to keep avoiding what you really have to do.

Just ask Penn State University officials about this!

Politicians in Europe created too much debt in trying to remain in office by paying off their constituents in order to get re-elected.  When financial markets started to complain about the excesses of debt created, European officials claimed that the problems were caused by speculators and other “greedy bastards” that were trying to disrupt things for their own gain.  When things got worse, officials claimed that there was a liquidity crisis at hand, not a solvency crisis.  And, because it was a liquidity crisis, bailouts could resolve the issue by giving governments enough time to get their budgets in order. 

This did not work and when these officials finally came to accept the fact that they might have to deal with the insolvency of their countries, they began working on a “new gimmick” that a default really was not a default…if it were voluntary.

And, if the default was just voluntary then contracts written to insure against a default could not really be collected upon!

That is, the legal contracts that were written to insure parties against default are really worthless!

“If investors think debt terms can be changed by fiat, they will flee the market.  Ditto, if they find that their insurance can be made worthless.” 

“The discussions with BNP Paribas confirm the view of some investors that credit default swaps are not insurance at all, but rather instruments that big banks use to benefit themselves.”

Hello, Occupy Wall Street!!!  

My prediction: “the debt mess in Europe” is not going to be cleared up until people stop lying to themselves and really start to address the issues that are outstanding.  The problem with this, as I have written about many times before, is that I see no leaders in Europe that are willing to stand up and really discuss the issues that are outstanding. (See my post: “In Europe the Issue is Leadership,”  

The sovereign debt problems that Europe faces are problems of solvency.  How many times does someone have to say this!  Until the officials of Europe address this problem “head on” and really try to “get their hands around it” they will continue to come up with “screwball” ideas like the one that Morgenson writes about in the Sunday NYTimes.

Resolving solvency problems are not easy and I’m sure this is why many European officials “put off” going for a real solution.  Solving solvency problems are going to cause a lot of hurt and pain…and will take a lot of time to correct. 

Unfortunately, there was a lot of hubris connected with the conceit of many European governments, a conceit that these governments could engineer high rates of employment and a social infrastructure that took care of all ills within a world in which there would be no international repercussions for such excessive and undisciplined behavior.

Unfortunately, there are no “good” solutions to living beyond ones means for an extended period of time.  If you “screw up” you finally end up paying for it.  And, solving the problem can hurt many, many people.     

Friday, November 18, 2011

Signs of the Future: Emerging Countries vs. Developed Countries

The world goes on.  Whereas the news has tended to be dominated by what is happening in Europe, with some attention going to the United States, things are still going on in other parts of the world. 

For example, “Standard & Poor’s has become the third rating agency this year to upgrade Brazil’s sovereign debt…” (

“Brazil’s debt fundamentals are already seen by markets as superior to many European countries with spreads on the Latin American country’s debt trading tighter than those of many eurozone countries.”

“The move…emphasizes the growing divergence between the fast-growing large emerging markets, led by China, Brazil, and India, and the advanced economies.”

Meanwhile, the central banks in emerging markets are buying gold in the largest quantities for forty years.  The forty years is important for that refers back to 1971 when President Richard Nixon severed the tie between the United States dollar and gold. 

“The scale of the purchases was bigger than previously disclosed and puts central banks on track to buy more gold than at any time since the collapse of the Bretton Woods system 40 years ago, when the value of the dollar was last linked to gold.”  (

Many emerging countries, especially the BRICs, now believe that they are over-exposed to the dollar in their central bank reserves and are trying to build up gold reserves at times when the price of gold dips.  Also, there is incentive to buy as concerns grow over the role of the United States dollar as a reserve currency.

“It is a mark of creeping distrust in the unofficial reserve currency, which nervous central bankers see being printed by trillions even as America’s political leadership shows no sign of dealing with its daunting fiscal challenges.  Fiscal worries are even more acute for the number two and three reserve currencies, the euro and the yen.” (

But, “Central bankers are late to the gold party.  Private buyers of ETFs alone have accumulated 15 times as much since their advent a decade ago as government bought last quarter.  But their shift should be of far more concern.”

Seemingly oblivious to these happenings, the United States continues to pursue policies that will devalue its currency.  Fed Chairman Ben Bernanke appears to be focused on keeping the world abundantly supplied with U. S. dollars while Treasury Secretary Timothy Geithner continues to swear that U. S. policy is to maintain a “strong” dollar while the Obama administration continues to issue more and more debt. 

Others within the Federal Reserve System continue to back up the Fed effort to continue to inflate the world.  The President of the Federal Reserve Bank of New York, William Dudley, says that “the central bank isn’t out of ammunition “ and that “monetary policy must do its part” to support economic growth. (

And, the pressure in Europe is intense to get the European Central Bank to engage in much more aggressive actions to save the European Union and the euro.  Is quantitative easing in the future for Europe? (

The emerging nations are seeing the “crack in the door” and are steadily moving to take advantage of the fact that the developed countries must currently keep their focus on current distractions.  By following such a policy they see “the door” opening wider and wider.

To me, the real report card is the value of the dollar.  The credit inflation of the last fifty years in the United States, first, forced the United States off the gold standard, and, second, resulted in a secular decline in the value of the dollar.  The U. S dollar still fluctuates near the lows reached over the past forty years since its value was floated.


Looking at the value of the dollar against twenty major currencies one can see that news lows were hit around August of this year.  One can note that the three periods of recovery from the lows reached in 2008 were periods when there was a “rush to quality”.  The first was during the “Great Recession” and the other two spikes came during the sovereign debt crises in Europe. 

The economic policies of the United States government aim at a devaluation of the United States dollar.  Still the United States dollar is the reserve currency of the world and is the currency of the country that remains the strongest country economically.  This is why the United States dollar is still the haven for others when there is a movement to “quality.” 

Since the second world war, the United States…with western Europe tagging along…has dominated the world, economically as well as militarily.  During this time, the United States has basically acted independently of all others.  It is still “Number One” in these areas but is finding that its voice is growing weaker and weaker.  Current examples of this are the position the U. S. had to take in the actions in Libya and the back seat it took in the G20 meetings in Cannes, France.  And, more and more it is finding that with its fiscal position that it just does not have the money to “throw at things” that it used to have in the past. 

One way or another, the separation between the developed countries and the emerging countries is going to be a major factor in the world going forward.  Most analysts have moved up the time they expect some of the larger emerging nations to catch up with America and western Europe.  Within this environment, the currency conflicts and the financial conflicts are just going to grow

Wednesday, November 16, 2011

China and Others are Waiting to See How the West Solves Its Problems

“Germany’s continued prosperity has helped fuel growing anger in countries like Greece and Spain against what is increasingly viewed as harsh German domination.  More and more, Germany is cast in the role of villain, whether by protesters in the streets of Athens or by exasperated politicians in the halls at the Group of 20 meetings in Cannes, France.” (

This quotes reminds me of a quote of Warren Buffet’s: You have to wait until the tide goes out to find out who is wearing a bathing suit and who is not wearing a bathing suit.

During an extended period of credit inflation like the one experienced by the United States, the UK, and Europe over the past fifty years “success” seems to apply to everybody.

An example I have experienced in my years as a bank executive is the area of residential real estate construction.  During this fifty-year period of credit inflation it seemed as if almost everyone and his brother or sister could build houses and become a successful real estate construction executive. 

One found out, however, when the credit inflation stopped who was a good builder and who was just coasting along on the inflationary wave and who really built very good houses. 

And those that just “put up” houses resented the success of the really good builders and gripped about those that continued to prosper when times were not so lush.

We are seeing this shake out in Europe these days as Germany, known for the discipline of its people and the work ethic embedded within the society, continues to prosper with a relatively healthy economy and a strong export component of its Gross Domestic Product. 

“When the tide goes out” there is a higher probability that the hard working and disciplined nation will come out on top.  And, we are seeing that in the case of the eurozone. 

The difficulty in maintaining that discipline and commitment to hard work is that during the period of credit inflation you see other nations getting by with a lot less discipline and a lot less work.  It is very easy during this time period to reflect on the fact that the others are getting by much more cheaply and are still doing pretty well.  And, the move to the “easy side” does not have to come all at once…it is easy to give up a little here and a little there…and slide, incrementally into the opposite pattern.

One can think of the comment by former Citigroup Chairman and CEO “Chuck” Prince who famously said that one must keep dancing as long as the music is playing. 

As long as the period of credit inflation continues, increased risk taking, increased financial leverage, and increased interest rate risk taking pays off.  Financial betting also pays as manufacturing firms, like General Motors and General Electric, reduce their focus on production and increasingly become financial companies.  

Some nations and some corporations do maintain their discipline during these times and although they indulge in the credit inflation game, they control their risk exposure so that once the “dancing” stops, they can maintain their position and continue to prosper.  JPMorganChase is an example of this.  Also, there were a number of manufacturing companies that did not “over indulge” in the financial frenzy created by their governments.  These companies now are sitting on piles of cash, buying back their stock or engaging in a very “ripe” acquisition market. 

During such an extended time, one cannot totally ignore the environment of credit inflation that has been created.  The task is not to be overcome by the exuberance and excesses of the time, and maintain and control the exposure of the nation or corporation to the environment and incentives that has been created by the economic policies of the other governments and corporations.

There is no question that this is a very hard thing to do.  Yet, that is what the ultimate winners do!  Super Bowl champions are invariably built on strong defenses with a good offense.  The winners do not often come from teams that are just built to score a lot of points.  Companies that continually push the edge of financial leverage and risk-taking to gain a few more basis points for their return on equity do not survive over the longer-run.

When the bubble bursts, as it has done now, those that have maintained their discipline throughout the “loose” times are the ones that are usually left to dictate the terms of the future, whether it be the future of nations, or, the future of industries.  And, those that achieve that dominate position are not liked, are resented, and are only grudgingly followed.       

“As the overall health of Germany’s economy and its fiscal position widen the rift with Europe’s poorer periphery, Germans have a ready response.  They say that they already made the structural changes in work-force rules and pension reforms that they are now recommending for the slow-growth countries, and that, by the way, they actually pay their taxes. So if the laggards want Germany’s money, they have to play by German rules.”

This is hard-nose stuff!  And, it seems heartless to those that have to go though the “wrenching” economic changes that are being proposed for the “laggards”.  For, what about those people who were just “unlucky” and were in the wrong spot at the wrong time.  And, what about the “disadvantaged” that had nothing to do with the regime of credit inflation? Just saying that the governments should have been thinking about these people when they went on their credit inflation binge is not very satisfying to these people.

Yet, nations…and corporations…and people…that control their excesses and remain disciplined over time have a better track record than those that don’t.  The loss of control and the loss of discipline seem to come when nations…and corporations…and people…become short-sighted and think that they can continuously maintain short-term gains over the longer-haul. 

But, the philosophy that we should not worry about the longer-haul because “in the long-run we are all dead” is not pragmatic…either for us…or for those coming after us.  The long-run does come about…and we pay…and we may pay a lot…if we have just focused on the “highs” we get from short-term excesses.

The United States, the UK, and Europe are all paying for the excesses of the credit inflation of the past.  The question that remains to be answered is whether or not these excesses will be corrected in the near term.  Others…China…Russia…Brazil…India…and others…are waiting to see what happens.  

Tuesday, November 15, 2011

What If Europe "Marked-to-Market"?

“The now inevitable restructuring of eurozone debt…”

So writes Jim Millstein, Chairman of Millstein & Co. and former chief restructuring officer of the US Treasury Department. (

Have people really come to accept this fact?

The full sentence: reads “The now inevitable restructuring of eurozone debt will result in bank capital deficiencies that the IMF estimates could exceed €300 billion.”

Now, what if we added a European recession on top of this, a recession that would slow down government receipts and increase unemployment payments and so forth?

Just out this morning: “A rebound in German and French growth propelled a modest expansion of the eurozone economy in the third quarter of this year – but failed to dispel fears of a looming recession across the 17-country region.

Eurozone gross domestic product expanded 0.2 per cent compared with the previous three months – the same pace of expansion as in the second quarter, according to Eurostat, the European Union’s statistical office. But with the escalating debt crisis already feeding into falling factory production, growth may already have gone into reverse, economists warned.” (

Are we coming to the end game?

Angela Merkel, the German chancellor, is now calling for a political union of Europe as the only way to “underpin” the euro and help the members of Europe emerge from their “toughest hour since the second world war.”

Doom and gloom seem to be all around us.  Just in the past two days we have articles like “New Austerity Incites a Bitterness the Postwar Generation Did Without,” ( and David Brook’s “Let’s All Feel Superior,” (  Also, this morning there is a review of Niall Ferguson’s new book “Civilization” whose subject matter is “the end of western civilization as we know it”  (

Do these pieces of information point to the existence of a debt deflation cycle that is at the opposite end of the spectrum from the credit inflation cycle that we have been going through for the past fifty years? (

The solutions Mr. Millstein proposes for the writing down of European sovereign debt are focused on the banking system and the estimated bank capital deficiencies.  But, part of the solution involves more debt: “a federal financial body, such as the European Investment Bank, must provide a capital backstop…”  In other words, more debt!

But, “To give it the firepower it needs for the size of the problem, the EIB must be empowered to raise debt supported by a stream of new tax revenues dedicated to retire the debt incurred.”  And, “the EIB’s capital backstop should be funded through a new federal tax on bank salaries and profits above defined levels.”

This does not seem like a solution to me.  The solution to the problem of too much debt around is not more debt and more taxes.  Yet that seems to be the best that many people can come up with.  However, this seems to me to be more of the same “thinking” that got us into this situation.

This brings me back to the opening quote: “The now inevitable restructuring of eurozone debt…”

The European problem is not a new one; it has been growing for several years now.  Government officials have just not been willing to accept the reality of the situation and economists have helped them to hide their heads in the sand by arguing that Europe’s problem has been one of “liquidity” and not one of “solvency.” 

If the problem is one of “liquidity” then a bank…or, anybody else…does not have to mark down an asset because the bank will, they say, hold the asset until it matures.  If the bank accepted the fact that the asset was experiencing difficulties then it would have to “mark” the value of the asset down.  But, this admits that something might be wrong…and people don’t like to admit that a mistake might have been made.

And, as Steven Covey has stated, “if the problem is ‘out there’, that is the problem!”  Even a month ago, European officials were still claiming that their problem was one of “liquidity” brought on by speculators and other “greedy bastards.”  And, if the problem was someone else’s fault, real solutions could be postponed.  And that is what these officials did.

“Solvency” problems, however, do not just go away.  First, “solvency” problems have to be recognized…people have to “own” them before anything can be done about them. 

I am still not convinced that we have arrived at that point.  Yes, we have an editorial piece in the Financial Times that declares that “the inevitable restructuring of eurozone debt” must take place.  However, eurozone governments, I don’t believe, generally accept this conclusion. 

Until eurozone officials do accept the fact that “all” eurozone debt must be restructured, the problem will still be that these officials do not accept the fact that their debt must be restructured.  And, this is no solution.    

Monday, November 14, 2011

Business Loans Continue to Increase

The largest twenty-five domestically chartered commercial banks in the United States continue to increase lending to businesses (Commercial and Industrial Loans) over the latest four-week period according to the most recent Federal Reserve data.  Over the latest four-weeks ending November 2, large banks experienced a net increase in business loans by almost $11 billion.  Over the latest 13-week period, these loans have risen by almost $28 billion. 

From October 2010 to October 2011, the largest twenty-five banks have increased their portfolios of these business loans by a little more than $75 billion.

Still, one does not have a lot of confidence that these loans are going into areas that will contribute to the growth of the economy.  Larger companies are still accumulating “cash” to buy back stock or to make acquisitions.  Certainly the cost of borrowing is not a hindrance to these companies obtaining for these purposes these days. 

Commercial and Industrial loans have also increased in the rest of the banking system, but by a little more than one billion dollars over the last four weeks, and by just over $9 billion over the past 13 weeks.  It is not altogether clear what these loans are going for at the present time.  Given that this $9 billion increase is spread through about 6,400 banks, the rise in lending at each bank, on average, is not too great.

The interesting thing about the lending in the smaller 6,400 banks is that residential real estate loans have shown some increase over the past 13-week period.  Residential loans have risen by almost $25 billion over the past quarter, over $13 billion in the last four weeks alone.  The indication is that in some places in the United States, residential lending activity has been picking up.  We will have to watch this number closer in the upcoming weeks and months. 

The softest area in lending still remains the commercial real estate area and the weakness is predominantly in the small- to medium-sized banks.  These loans dropped by slightly less than $14 billion over the past 13-weeks, with more than half the decline at the smaller banks.  Over the past 4-weeks the declines in commercial real estate loans have all been outside the largest 25 banks in the country. 

All domestically chartered commercial banks in the United States reduced their holding of cash balance in the past 13-week period.  The largest 25 commercial banks lowered their balances by $185 billion. The other domestically chartered banks reduced their holdings by only $10 billion.  These decreases in cash balances came despite the fact that excess reserves in the banking system stayed relatively constant during this time period. 

In summary, the latest Federal Reserve statistics indicate that the banking system, as a whole, is becoming less conservative.  Business loans have been picking up for most of the last six months, especially at the largest 25 domestically chartered banks in the United States.  The question mark here, however, is the use that borrowers are putting these funds to.  It does not appear as if the loans are being used for productive purposes that would get the economy moving again. 

The commercial real estate area continues to stay week, especially at small- and medium-sized banks.  Here one still has questions about the quality of these loans on the balance sheets of the smaller banks and the implication of these difficulties for the future.   

One further note: Consumer borrowing at all commercial banks continues to remain weak.  Nothing seems to be happening in this area, which, again, has implications for future economic growth.  The consumer seems to be more interested in getting his/her debt under control than to really engage in more spending.  We will see what happens in this area as the holiday season approaches.

Closing note:  The largest 25 commercial banks in the United States, according to the Federal Reserve data, represented 57 percent of the assets in the banking system on November 2, 2011; foreign-related depository institutions represented 14 percent; and the other (roughly) 6,400 domestically chartered banks represented 29 percent.