I am still worried about what banks aren’t telling us.
Why?
Total Reserves in the banking system have increased by $857.8 billion over the twelve month period ending in May 2009. Excess reserves in the banking system have increased by $842.1 billion in the same time period.
The Federal Reserve System has overseen a 1,900% increase in total reserve in the banking system, year-over-year, for the year ending May 2009, and banks have chosen to sit on the injection almost dollar-for-dollar!
These figures come from the Federal Reserve statistical release H.3 “Aggregate Reserves of Depository Institutions and the Monetary Base.” I have used the “not seasonally adjusted” data.
This is unheard of! In May 2008, excess reserves were $2.0 billion and stood at 4.5% of the total reserves in the banking system. In May 2009, excess reserves totaled 93.7% of the total reserves in the banking system.
Unless someone can convince me otherwise there are, in my mind, only three reasons for this behavior. The first is the volume of bad assets currently on the balance sheets of banks that have not been recognized. The second is the volume of bad assets that banks anticipate will be forthcoming over the next year or so. The third has to do with how the banks have funded themselves in the past several years.
If these assumptions are correct, the recession cannot be called over yet and any economic recovery that might be forthcoming is going to be relatively tepid or postponed for some time. I obviously hope that I am wrong but something just does not “foot” with the data that I have reported above.
In the first category, current bad assets on the balance sheet, one would think that we know a fair amount about them. Their volume was sufficiently large so that the government put into place the TARP program and then followed that up with the idea of the P-PIP. Several banks feel sufficiently strong that they are returning their TARP money and it appears as if the P-PIP will never be actually implemented.
Financial markets have responded favorably to these events. Yet, we know that there still remain a large number of bad assets in the banking system. The current confidence has allowed some banks to return the TARP funds wanting to get the “Feds” out of their buildings and out of their compensation committees. In addition, with the relative calm in both financial and economic markets, confidence has risen within the banking system that maybe they can ride out the rest of the way to recovery, hoping that many of the remaining bad assets will turnaround or be refinanced or be worked with.
In my experience working in the banking sector, “hope seems to spring eternal” when it comes to believing that bad assets will eventually become good assets. The attitude is that “with time” the borrowers will come through.
But, what kind of confidence is it that sits on $844.1 billion in excess reserves, funds that are earning no return to the banks? Required reserves in the banking system in May only totaled $58.8 billion. What am I missing?
Let’s look at the second category, that about debt coming due or repricing in the future. We have seen more and more reports in recent weeks about the Option Mortgages that are coming due over the next 18 months or so; we read about all the commercial mortgage debt that is on the edge and this was accentuated this week with the bankruptcy filing of Six Flags; and we know that credit card delinquencies are still rising. What we don’t know is the extent of the fallout from the bankruptcies in the auto industry and how this will impact those industries and regions that have depended upon a healthy car business. In addition, personal bankruptcies and small business bankruptcies continue to rise and there is really no firm information about when the increase in these will moderate and what the effect on the banking system will be.
Finally, there is the problem of financing the banking system itself. I recommend that you take a look at the article by Gretchen Morgenson in the June 14 New York Times, “Debts Coming Due at Just the Wrong Time.” (http://www.nytimes.com/2009/06/14/business/14gret.html?ref=business.) Morgenson writes about the debt of the banking system and the need for bank balance sheets to shrink. The banking system, itself, needs to de-leverage and may have to do so unwillingly.
In this article, Morgenson refers to a study by Barclays Capital that discusses the amount of debt of financial companies coming due over the next year or two. The figures, roughly $172 billion of debt will mature in the rest of 2009 and $245 billion will mature in 2010. This means that financial institutions will have to refinance about $25 billion a month for the next 18 months or so. Part of the problem in refinancing this debt is that “many of the entities that bought this debt when it was issued aren’t around any more.” Furthermore, in general, “few buyers of short-term bank debt are around now.”
Raising equity capital is fine, but, over then next few years, the banks may have a larger hole to finance in terms of the debt that it must try to roll over. This, of course, will put more pressure on the policy makers. The policy makers have gone out on a limb in attempting to protect the need to write down bad assets. The policy makers have provided capital for some of the banks that were in the worst financial shape. The next issue has to do with the need for the purchase of bank liabilities. This may be a very tough balancing act to complete successfully.
But, maybe the government has already provided the funds to meet these emergencies. Maybe that is why banks are holding such large amounts of excess reserves. They know that over the next 18 months that they are going to have a severe funding problem. Excess reserves are the perfect answer to paying off the debt as it runs off, leaving the banks with a lot of funds that still can buy them time to “work out” the bad assets that remain on their balance sheets.
Showing posts with label P-PIP. Show all posts
Showing posts with label P-PIP. Show all posts
Sunday, June 14, 2009
Thursday, June 4, 2009
P-PIP, R. I. P.?
Shall we say, Rest In Peace to the P-PIP? Considered from its beginning as an ill-conceived program of the Treasury Department, the Federal Deposit Insurance Corporation has delayed a test auction for the placement of toxic assets which seems to unofficially declare P-PIP DOA. The sooner this effort is totally put to bed the better off we will all be.
P-PIP was always conceived as a program to deal with the illiquidity of bank loans and securities. The difficulty with this is that the real problem was one of solvency. That is, the problem was not about the sale-ability of the loans or assets. The problem was that the banks would need to take such a large write-down of asset values if the solvency of the loans and securities were truly accounted for that the banks, themselves, would face the threat of insolvency.
The P-PIP was an attempt to limit the write-down in asset values so that the banks would not have to directly face the insolvency issue. The Federal Government would use tax-payer dollars to provide the floor for the write-downs. This would avoid, in the minds of government officials, an alternative to “nationalization” of the banks.
The environment has changed. Now that emotions have settled down a little bit, banks (and regulators) are dealing with the loan and securities problems a little more calmly. They are attempting to “work things out” and not “run for the doors.” The ability of banks to raise more capital has also contributed to this new, calmer atmosphere.
In a credit bubble, like the one created by the Federal Reserve earlier this decade, the economic system becomes more and more fragile as institutions seek to achieve adequate returns by manipulating their financial structure. As spreads narrow, management efforts to earn competitive returns focus more and more on financial engineering such as taking on more and more risky assets, and, financing these assets with more and more leverage and by shorter and shorter term liabilities.
The real crisis occurs when the bubble pops and everyone runs for the door at the same time. The Federal Reserve created the incentives that resulted in the financial engineering and since the engineered structures, at some point, become unsustainable the following collapse becomes systemic!
Financial innovation and the creation of derivatives and other financial instruments over the past forty years or so has made the financial markets more efficient--except when everyone tries to leave the game at the same time. The real problem is that financial innovation cannot make up for bad government policy, especially if the central bank is not independent of the government of a country.
When the bubble bursts there is at first fear, as everyone realizes that they are highly exposed. Then, things settle down a bit, but still there is a high level of emotion as people look for short-cuts to get out of their positions. Then people begin to look at their portfolios more realistically and start to work through the problems they identify.
The one real crucial element in moving to this last position is fully understanding and accepting how bad the problems are. Having worked in three bank turnarounds I understand how important it is for the managements of these organizations to face their situation realistically. One can only work one’s way out of a difficult situation if one is completely honest about what needs to be done.
It appears that in the last month or so, more bank managements have moved toward a realistic approach to working out their asset problems. Things are not rosy yet, but things have calmed sufficiently so that banks have raised additional capital where they can and they have weighed the trade-off between selling assets into a P-PIP like program and decided that they are better off relying on their own efforts than those of the government. A good choice in my mind!
There are still going to be bank failures. In fact the number of bank failures projected for this year has ranged from 100 to 1,000. In order to help work through these failures, the FDIC has presented a program to deal with the troubled assets of failed banks that is modeled upon the Resolution Trust Corporation. This program will provide debt guarantees to organizations issuing debt used to buy the troubled assets of failed banks. This seems like a more legitimate way to work with private interests in settling the affairs of banks that have already gone into receivership.
Good riddance to the P-PIP if, in fact, the idea of the P-PIP is expiring. We need to move on and we need to move on where ever possible without the government playing an excessive role in the solution. The problems are not over, but the problems of financial institutions need to be handled by the financial institutions themselves. But, if everyone is not running to the door at the same time the financial system should be able to work through their difficulties.
In no way does this mean that things will be easy. Information released yesterday indicates that bankruptcies, both personal and commercial, continue to increase. Personal bankruptcies in May ran in excess of 6,000 per day, up about 150 per day over April, and commercial bankruptcies rose to 376 per day, up about 125 per day over April. Continuing at this pace, bankruptcy filings could reach 1.5 million this year. And, the full impact of the collapse of the auto industry is still to be felt.
P-PIP may be going away, but the financial crisis has not yet expired. The good news is that financial institutions are now going about their business in a more orderly manner. The bad news is that the bad news with respect to financial institutions is not going to go away.
Furthermore, the bad news is that working through these problems is going to take a long time. The good news is—that they can be worked through.
P-PIP was always conceived as a program to deal with the illiquidity of bank loans and securities. The difficulty with this is that the real problem was one of solvency. That is, the problem was not about the sale-ability of the loans or assets. The problem was that the banks would need to take such a large write-down of asset values if the solvency of the loans and securities were truly accounted for that the banks, themselves, would face the threat of insolvency.
The P-PIP was an attempt to limit the write-down in asset values so that the banks would not have to directly face the insolvency issue. The Federal Government would use tax-payer dollars to provide the floor for the write-downs. This would avoid, in the minds of government officials, an alternative to “nationalization” of the banks.
The environment has changed. Now that emotions have settled down a little bit, banks (and regulators) are dealing with the loan and securities problems a little more calmly. They are attempting to “work things out” and not “run for the doors.” The ability of banks to raise more capital has also contributed to this new, calmer atmosphere.
In a credit bubble, like the one created by the Federal Reserve earlier this decade, the economic system becomes more and more fragile as institutions seek to achieve adequate returns by manipulating their financial structure. As spreads narrow, management efforts to earn competitive returns focus more and more on financial engineering such as taking on more and more risky assets, and, financing these assets with more and more leverage and by shorter and shorter term liabilities.
The real crisis occurs when the bubble pops and everyone runs for the door at the same time. The Federal Reserve created the incentives that resulted in the financial engineering and since the engineered structures, at some point, become unsustainable the following collapse becomes systemic!
Financial innovation and the creation of derivatives and other financial instruments over the past forty years or so has made the financial markets more efficient--except when everyone tries to leave the game at the same time. The real problem is that financial innovation cannot make up for bad government policy, especially if the central bank is not independent of the government of a country.
When the bubble bursts there is at first fear, as everyone realizes that they are highly exposed. Then, things settle down a bit, but still there is a high level of emotion as people look for short-cuts to get out of their positions. Then people begin to look at their portfolios more realistically and start to work through the problems they identify.
The one real crucial element in moving to this last position is fully understanding and accepting how bad the problems are. Having worked in three bank turnarounds I understand how important it is for the managements of these organizations to face their situation realistically. One can only work one’s way out of a difficult situation if one is completely honest about what needs to be done.
It appears that in the last month or so, more bank managements have moved toward a realistic approach to working out their asset problems. Things are not rosy yet, but things have calmed sufficiently so that banks have raised additional capital where they can and they have weighed the trade-off between selling assets into a P-PIP like program and decided that they are better off relying on their own efforts than those of the government. A good choice in my mind!
There are still going to be bank failures. In fact the number of bank failures projected for this year has ranged from 100 to 1,000. In order to help work through these failures, the FDIC has presented a program to deal with the troubled assets of failed banks that is modeled upon the Resolution Trust Corporation. This program will provide debt guarantees to organizations issuing debt used to buy the troubled assets of failed banks. This seems like a more legitimate way to work with private interests in settling the affairs of banks that have already gone into receivership.
Good riddance to the P-PIP if, in fact, the idea of the P-PIP is expiring. We need to move on and we need to move on where ever possible without the government playing an excessive role in the solution. The problems are not over, but the problems of financial institutions need to be handled by the financial institutions themselves. But, if everyone is not running to the door at the same time the financial system should be able to work through their difficulties.
In no way does this mean that things will be easy. Information released yesterday indicates that bankruptcies, both personal and commercial, continue to increase. Personal bankruptcies in May ran in excess of 6,000 per day, up about 150 per day over April, and commercial bankruptcies rose to 376 per day, up about 125 per day over April. Continuing at this pace, bankruptcy filings could reach 1.5 million this year. And, the full impact of the collapse of the auto industry is still to be felt.
P-PIP may be going away, but the financial crisis has not yet expired. The good news is that financial institutions are now going about their business in a more orderly manner. The bad news is that the bad news with respect to financial institutions is not going to go away.
Furthermore, the bad news is that working through these problems is going to take a long time. The good news is—that they can be worked through.
Tuesday, April 28, 2009
Renouncing the Debt
There are three ways to get out of a debt crisis. First, you can work off the debt, but this takes a long time. An impatient public and an impatient government will not have the stomach the wait that would be necessary for individuals, families, and businesses to get their balance sheets in order so that a recovery can get started.
The second method is to inflate or reflate yourself out of the nominal debt burden you have created. The Federal Reserve is doing its best to create an inflationary environment so that the real value of the debt will be reduced and individuals, families, and businesses will feel comfortable enough to begin borrowing and spending once again.
The third way to reduce the burden of your debt is to repudiate the debt. That is, declare that you will not pay the debt and that those that issued the credit to you will have to take only a partial payment on the amount of funds that they advanced to you. The partial payment, of course, can be zero.
The latter two methods have an “honorable” history that goes back centuries. (Read almost anything by Niall Ferguson.) Usually, it is the government that can get away with either or both of these efforts, but in the 20th century, the private sector got much better in following the lead established by governments, especially repudiating the debt. Individuals, families, and businesses learned the ropes of debt repudiation and are now taking this knowledge to new extremes.
The case that is before everyone’s eyes these days is that of the automobile industry. Both General Motors and Chrysler argue that bondholders must take a huge cut in the amount of money they are owed by these companies so that the companies can survive and thousands and thousands of jobs can be saved. The bondholders, remarkably, have some reluctance to consent to this offer. As of this date, the aimed for restructuring of these two companies depend upon what is worked out between the companies and the bondholders.
Best guess is that the bondholders will lose. And, who will own the auto companies? Not the existing shareholders. The figure I have heard for General Motors is that existing shareholders will end up with about 1% of the ownership of the company after the restructuring takes place. And, not the existing bondholders. The biggest shareholders? The federal government and the labor unions.
The important thing, however, is that the debt problem being experienced by these automobile companies will be resolved. That is, the companies can move forward, leaner and meaner, without the terrible burden of having to honor the debts they had contracted for.
Furthermore, this is what has been proposed for the banking industry. In the plan to sell off bad assets, aren’t the banks being asked to repudiate a large portion of the debt they have on their balance sheets? The assets will be sold to investors and private equity firms to “manage” and this will get the banks out from under the burden of the “toxic assets” they have accumulated.
And, who will bear the risk of this buyout? The federal government, with the real possibility that it may, depending upon the way things work out, end up owning large portions of some of the larger banks. (An important critique of this program is presented by the economist Joseph Stiglitz in “Obama’s Ersatz Capitalism,” http://www.nytimes.com/2009/04/01/opinion/01stiglitz.html?scp=8&sq=jospeh%20stiglitz&st=cse.)
Might this plan work? Well, the people that the federal government wanted to get interested in the plan seemingly smell blood. We read this morning that Wilbur Ross and his firm’s parent company, Invesco, are leading a consortium that is going to bid on some of the assets in the government’s P-PIP. He is joining some other prominent money, like BlackRock, Pimco and Bank of New York Mellon, interested in getting involved in the program.
Do these people think that they might make some money out of this program? Do they believe that the risk-reward tradeoff is skewed in their direction? Damn betcha’.
Here is another case of “watch where the big money players put their money.” My guess for the future is that the evolving banking system is going to be somehow connected with the hedge funds and the private equity funds and will not have the same old “bank on the corner” feel to it that we experience now. And, somehow, this new banking system will be even harder to regulate than the current one. Otherwise, this money will not flow there. (Something to think about for the future.)
With these funds flowing into the P-PIP, one of the things the federal government is going to have to face is the huge profits that these companies will make out of the program. On the one hand, if P-PIP is successful in this way and these funds make huge profits, the banks will be freed up of their “toxic assets” and the tax payer will not be burdened with more taxes. On the other hand, the federal government will have to explain how it catered to all these “Wall Street Interests” and left the poor Main Streeter in his or her poverty.
The essence of the plan, getting back to the story here, is that the banks will have to take the “haircut”, the write down on the value of their assets. This is just another way of repudiating the debt, with the federal government standing behind the banks. Is it fair? Of course not!
A fund that made the wrong bet was Cerberus Capital Management. In a real sense, it hoped to do with Chrysler Corp. what Invesco, BlackRock, Pimco, and others, are hoping to do with the bank assets. It just got in too early when Chrysler was not in bad enough shape for the federal government to attach a “put” to the investment Cerberus made in the company. Too bad for Cerberus.
But, what about all the other debt out there? Mortgages on homes, debt on commercial real estate, consumer credit and credit cards, and small business loans? Why shouldn’t the people that accumulated all this debt get some relief as well? This is, of course, the big question and the big issue in terms of fairness. The basic answer to this is, as usual, size. The banks and the auto companies and others are big, their failures could case systemic problems for the system, and they have expensive lawyers and lobbyists working for them. Is it fair? Of course not!
The fundamental problem that is being faced around the world is a debt problem. There is just too much debt outstanding. And, actually, the amount of debt outstanding in the world is really not shrinking. Especially, as governments increase their debt to cover the debt that has been built up in the private sector. The debt problem is going to be with us for a while and will continue to get in the way, one way or another, of any kind of a robust recovery. How we get through it is going to set the stage for the type of world we have to deal with in the future.
The second method is to inflate or reflate yourself out of the nominal debt burden you have created. The Federal Reserve is doing its best to create an inflationary environment so that the real value of the debt will be reduced and individuals, families, and businesses will feel comfortable enough to begin borrowing and spending once again.
The third way to reduce the burden of your debt is to repudiate the debt. That is, declare that you will not pay the debt and that those that issued the credit to you will have to take only a partial payment on the amount of funds that they advanced to you. The partial payment, of course, can be zero.
The latter two methods have an “honorable” history that goes back centuries. (Read almost anything by Niall Ferguson.) Usually, it is the government that can get away with either or both of these efforts, but in the 20th century, the private sector got much better in following the lead established by governments, especially repudiating the debt. Individuals, families, and businesses learned the ropes of debt repudiation and are now taking this knowledge to new extremes.
The case that is before everyone’s eyes these days is that of the automobile industry. Both General Motors and Chrysler argue that bondholders must take a huge cut in the amount of money they are owed by these companies so that the companies can survive and thousands and thousands of jobs can be saved. The bondholders, remarkably, have some reluctance to consent to this offer. As of this date, the aimed for restructuring of these two companies depend upon what is worked out between the companies and the bondholders.
Best guess is that the bondholders will lose. And, who will own the auto companies? Not the existing shareholders. The figure I have heard for General Motors is that existing shareholders will end up with about 1% of the ownership of the company after the restructuring takes place. And, not the existing bondholders. The biggest shareholders? The federal government and the labor unions.
The important thing, however, is that the debt problem being experienced by these automobile companies will be resolved. That is, the companies can move forward, leaner and meaner, without the terrible burden of having to honor the debts they had contracted for.
Furthermore, this is what has been proposed for the banking industry. In the plan to sell off bad assets, aren’t the banks being asked to repudiate a large portion of the debt they have on their balance sheets? The assets will be sold to investors and private equity firms to “manage” and this will get the banks out from under the burden of the “toxic assets” they have accumulated.
And, who will bear the risk of this buyout? The federal government, with the real possibility that it may, depending upon the way things work out, end up owning large portions of some of the larger banks. (An important critique of this program is presented by the economist Joseph Stiglitz in “Obama’s Ersatz Capitalism,” http://www.nytimes.com/2009/04/01/opinion/01stiglitz.html?scp=8&sq=jospeh%20stiglitz&st=cse.)
Might this plan work? Well, the people that the federal government wanted to get interested in the plan seemingly smell blood. We read this morning that Wilbur Ross and his firm’s parent company, Invesco, are leading a consortium that is going to bid on some of the assets in the government’s P-PIP. He is joining some other prominent money, like BlackRock, Pimco and Bank of New York Mellon, interested in getting involved in the program.
Do these people think that they might make some money out of this program? Do they believe that the risk-reward tradeoff is skewed in their direction? Damn betcha’.
Here is another case of “watch where the big money players put their money.” My guess for the future is that the evolving banking system is going to be somehow connected with the hedge funds and the private equity funds and will not have the same old “bank on the corner” feel to it that we experience now. And, somehow, this new banking system will be even harder to regulate than the current one. Otherwise, this money will not flow there. (Something to think about for the future.)
With these funds flowing into the P-PIP, one of the things the federal government is going to have to face is the huge profits that these companies will make out of the program. On the one hand, if P-PIP is successful in this way and these funds make huge profits, the banks will be freed up of their “toxic assets” and the tax payer will not be burdened with more taxes. On the other hand, the federal government will have to explain how it catered to all these “Wall Street Interests” and left the poor Main Streeter in his or her poverty.
The essence of the plan, getting back to the story here, is that the banks will have to take the “haircut”, the write down on the value of their assets. This is just another way of repudiating the debt, with the federal government standing behind the banks. Is it fair? Of course not!
A fund that made the wrong bet was Cerberus Capital Management. In a real sense, it hoped to do with Chrysler Corp. what Invesco, BlackRock, Pimco, and others, are hoping to do with the bank assets. It just got in too early when Chrysler was not in bad enough shape for the federal government to attach a “put” to the investment Cerberus made in the company. Too bad for Cerberus.
But, what about all the other debt out there? Mortgages on homes, debt on commercial real estate, consumer credit and credit cards, and small business loans? Why shouldn’t the people that accumulated all this debt get some relief as well? This is, of course, the big question and the big issue in terms of fairness. The basic answer to this is, as usual, size. The banks and the auto companies and others are big, their failures could case systemic problems for the system, and they have expensive lawyers and lobbyists working for them. Is it fair? Of course not!
The fundamental problem that is being faced around the world is a debt problem. There is just too much debt outstanding. And, actually, the amount of debt outstanding in the world is really not shrinking. Especially, as governments increase their debt to cover the debt that has been built up in the private sector. The debt problem is going to be with us for a while and will continue to get in the way, one way or another, of any kind of a robust recovery. How we get through it is going to set the stage for the type of world we have to deal with in the future.
Subscribe to:
Comments (Atom)
